Petition — Anderson, Clayton & Co. v. United States

Supreme Court brief1978

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In Tue

Supreme Court of the United States

Octroser TERM, 1977

Anperson, Crayton & Co.,

Petitioner,

Unrrep States or AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT

OF APPEALS FOR THE FIFTH CIRCUIT

C. W. WELLEN

Steven C. SaLcu

Cuarues E. Suniivan, JR.

Fulbright & Jaworski

800 Bank of the Southwest

Building

Houston, Texas 77002

Keiro A. Jones

Fulbright & Jaworski

1150 Connecticut Avenue, N.W.

Washington, D.C. 20036

FIDELITY PRINTING COMPANY, HOUSTON

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Appendix A

Opinion of the United States District Court for the South-

ern District of Texas, November 21, 1974 .....................00

Appendix B

Opinion of the United States Court of Appeals for the

Fifth Cireuit, November 11, 1977

Appendix C

Judgment of the United States Court of emetond for the

Fifth Cireuit, November 11, 1977 .............

Appendix D

Notice of Order Denying Petition for Rehearing and Re-

hearing En Bane, December 20, 1977

Appendix E

Relevant Provisions of the Internal Revenue Code of 1954,

as amended, and Treasury Regulations ..................cccss00+0

D-1

TABLE OF AUTHORITIES

Cases

PAGE

Central Illinois Public Service Co. v. United States, No. 76-

BROS (U.B., PRPURTT BG, UOTE) .nccecccccsccsecvcssccccsesccccccorsssncecs 8, 13

Chock Full O’ Nuts Corp. v. United States, 453 F.2d 300 (2d

Ef ee een 8-10

Commissioner v. Goodwyn Crockery Co., 315 F.2d 110 (6th

UIs. ATED” chslcilekcedniniiccincinimadsaeastidlbalett bends ctnisantintabeastvescetingaosnbnsndebin 7-10

Dizon v. United States, 381 U.S. 68 (1965) cee eeeeeeeees 9,10

Ezel Corp. v. United States, 451 F.2d 80 (8th Cir. 1971) .... 9,10

Fribourg Navigation Co. v. Commissioner, 383 U.S. 272

UNIT sich rid trea tslaknsehatenssaplaingleniaitignandiindkamniateaneisianiannienintltanis 12

Helvering v. R. J. Reynolds Tobacco Co., 306 U.S. 110

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United States v. California Portland Cement Co., 413 F.2d

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Statutes

Internal Revenue Code of 1954 (26 U.S.C.):

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iii

Miscellaneous

Revenue Ruling 77-86, 1977-1

Cum. Bull. 241

Revenue Ruling 76-535, 1976-2

Cum. Bull. 219

Treasury Regulations (26 C.F.R.) ‘y

Section

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In Tue

Supreme Court of the United States

OctTosEer TERM, 1977

No.

Anverson, Cuayton & Co.,

Petitioner,

Unitep States or AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT

OF APPEALS FOR THE FIFTH CIRCUIT

Anderson, Clayton & Co. petitions for a writ of certio-

rari to review the judgment of the United States Court of

Appeals for the Fifth Circuit in this case.

OPINIONS BELOW

The opinion of the Court of Appeals (App. B, infra) is

reported at 562 F.2d 972. The opinion of the District Court

(App. A, infra) is reported at 387 F.Supp. 601.

JURISDICTION

The judgment of the Court of Appeals was entered on

November 11, 1977 (App. C, infra). A timely petition for

rehearing, with suggestion of rehearing en banc, was denied

on December 20, 1977 (App. D, infra). The jurisdiction of

this Court is invoked under 28 U.S.C. § 1254(1).

QUESTION PRESENTED

Whether the United States, having lost this federal in-

come tax case in District Court, was entitled to appellate

reversal solely on the basis of the presumptive validity and

retroactive application cf a Treasury regulation that was

not promulgated until after the District Court’s decision.

STATUTES AND REGULATIONS INVOLVED

The pertinent provisions of sections 901, 902 and 904

of the Internal Revenue Code of 1954, as amended, 26

U.S.C. (1964 ed.) $$ 901, 902, and 904, and of Treas. Reg.

§§ 1861-7 (1957), 1.863-6 (1957), 1.901-2(d) (1957),

1.902-3(d)(1) (1975), and 1.963-4(1964), are set forth at

App. H, infra,

STATEMENT

Petitioner is a large, widely held corporation organized

under the laws of the State of Delaware (R. 4).! Petitioner

and its subsidiaries, during the taxable year in issue, were

engaged, inter alia, in the merchandising of cotton, coffee,

vegetable oils, and other commodities, the financing of

crops, and the processing and sale of food and animal

feed (R. 5). Petitioner is an accrual basis taxpayer and,

for the taxable year at issue in this case, used an annual

accounting period ending July 31 (id.).

This case arises out of petitioner’s computation of its

1“R.” refers to the record appendix filed in the Court of Appeals.

foreign tax credit for the taxable year ending July 31, 1964.

During that year, petitioner had received dividends and

other distributions from a number of its foreign subsid-

iaries, and petitioner and its foreign subsidiaries had paid

taxes on income to, inter alia, Argentina, Brazil, Mexico,

Peru, and Switzerland (R. 10-11; App. A, infra, p. A-5). In

these circumstances, petitioner was entitled under sections

901 and 902 of the Internal Revenue Code of 1954, as amend-

ed, 26 U.S.C. (1964 ed.) §§ 901 and 902, to a foreign tax

credit on account of the payments of foreign taxes. The

amount of the credit was subject, however, to the limitation

imposed by section 904 of the Code. For the taxable year

here at issue, section 904(a) permitted petitioner, in com-

puting its foreign tax credit, to choose between a “per-

country limitation” and an “overall limitation.”? Section

904(a)(1) provided that under the per-country limitation

“the amount of the credit in respect of the tax paid or

accrued to any foreign country .. . shall not exceed the

same proportion of the [domestic corporation’s federal in-

come tax which that corporation’s] taxable income from

sources within such country ... bears to [its] entire taxable

income for the same taxable year.’”®

The principal substantive tax issue that gave rise to

this litigation concerned the proper determination of the

2The alternative of a per-country limitation was eliminated for

taxable years beginning after December 31, 1975, by Section

1031 of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat.

1620.

3 Section 904(a)(2) provided that under the alternative overall

limitation “the total amount of the credit in respect of taxes

paid or accrued to all foreign countries . . . shall not exceed

the same proportion of the [domestic corporation’s federal

income tax which that corporation’s] taxable income from

sources without the United States . . . bears to [its] entire

taxable income for the same taxable year.”

“sources,” for the purpose of applying the per-country

limitation, of a distribution of $4,684,233.96 received by

petitioner during the taxable year from a Swiss subs diary,

Anderson, Clayton & Co., S.A. (hereinafter “Lausanne’’)

(R. 7).4 This distribution, which represented income that

Lausanne had earned during the year, included at least

$13,659.00 attributable to income derived from the purchase

and sale of commodities by Lausanne in Argentina, at least

$3,223,290.00 attributable to income derived from the pur-

chase and sale of commodities by Lausanne in Brazil, and

at least $15,517.49 attributable to income derived from the

purchase and sale of commodities by Lausanne in Peru

(R. 8).

At the time petitioner filed its amended return,’ the

Treasury regulations provided that, for taxable years be-

ginning after December 31, 1962, the principles of sections

861 through 864 of the Code, relating to the determination

of the sources of income, and the regulations thereunder

“shall apply in determining the sources of income

for the purposes of [the foreign tax credit provisions of

“Lausanne was a “controlled foreign corporation” within the

meaning of section 957 of the Code; the distribution to peti-

tioner was a “minimum distribution” under former section 963

of the Code that relieved petitioner of the necessity of including

in its income all of Lausanne’s “subpart F income” (R. 7).

See generally sections 951 through 964 of the Code. With ex-

ceptions not here relevant, the foreign tax credit of a domestic

corporation that becomes available as a result of a minimum

distribution made under section 963 is determined in accord-

ance with sections 901 through 905 of the Code. Treas. Reg.

§ 1.963-4(c) (1), 26 C.F.R. § 1.963-4(c)(1). See also App. B,

infra, p. B-9 to B-10.

5 Petitioner initially had filed a return using the alternative

overall limitation on the foreign tax credit; petitioner subse-

quently filed a timely amended return, using the per-country

limitation (R. 3).

the Code].” Treas. Reg. §1.901-2(d) (1957). See also

Treas. Reg. § 1.863-6 (1957). Application of those provisions

mutatis mutandis required the taxpayer to look to the place

where the income was earned, not to the place of incorpo-

ration. See, e.g., Rev. Rul. 76-535, 1976-2 Cum. Bull. 219;

Rev. Rul. 77-86, 1977-1 Cum. Bull. 241. In particular, the

regulations under sections 861 through 864 prescribe that

“income derived from the purchase and sale of personal

property shall be treated as derived entirely from the coun-

try in which the property is sold.” Treas. Reg. § 1.861-7

(1957).

Accordingly, in computing the per-country limitation on

its foreign tax credit for the year ending July 31, 1964,

petitioner treated $13,659.00 of the distribution from Lau-

sanne as having its source in Argentina, $3,223,290.00 of

the distribution as having its source in Brazil, and

$15,517.49 as having its source in Peru (R. 10-11). The

Internal Revenue Service rejected this treatment, taking

the position that, for the purpose of computing the per-

country limitation, as a matter of law the entire distribution

from Lausanne was required to be treated as having its

source in Switzerland, the country in which Lausanne was

incorporated, and disallowed $377,882.61 of petitioner’s for-

eign tax credit.

6 For taxable years beginning prior to January 1, 1963, the

applicable Treasury regulation had provided that, for the pur-

pose of determining the per-country limitation of section

904(a)(1), “dividends of a foreign corporation . . . shall be

deemed to have been derived from sources within the foreign

country ... in which such foreign corporation is incorporated.”

Treas. Reg. § 1.902-1(c) (1957). But as part of the readjust-

ment necessary to accommodate the changes in the treatment

of foreign source income worked by the Revenue Act of 1962,

Pub. L. 87-834, 76 Stat. 960, which added sections 951 through

964 of the Code, this regulation was declared inapplicable to

taxable years beginning after December 31, 1962. Treas. Reg.

§ 1.902-5(a) (1965).

Petitioner then instituted an action for refund in the

United States District Court for the Southern District of

Texas. The District Court, specifically noting the absence of

any regulation in support of the position taken by the

Service, held that petitioner’s method of computing the per-

country limitation was correct (App. A, infra, pp. A-3 to

A-10).’

While the case was pending on appeal, the Secretary of

Treasury promulgated Treas. Reg. § 1.902-3(d)(1) (1975),

which provided that “[f]or purposes of section 904(a) (1)

(relating to the per-country limitation), in the case of a

dividend received by a domestic shareholder from a first-

tier corporation there shall be deemed to be derived from

sources within the foreign country ... under which the

first-tier corporation is created or organized the sum of

the amounts . . . [that represent] income from sources

without the United States.’ This regulation states the rule

for which the government had argued unsuccessfully before

the District Court.

The Court of Appeals reversed. The Court observed

7 With respect to a second issue, the District Court sustained the

Service’s disallowance of a loss deduction of $278,892.29 at-

tributable to a decline in value of certain promissory notes

(App. A, infra, pp. A-10 to A-22). A third issue, involving the

question whether petitioner was entitled to a direct foreign tax

credit with respect to Mexican income taxes paid in connection

with dividends received from its Mexican subsidiaries, was con-

ceded by the United States at the commencement of the trial

(App. A, infra, pp. A-2 to A-3).

8 This regulation is now set forth at Treas. Reg. § 1.902-1(h)

(1977).

® Petitioner had taken a cross-appeal with regard to the loss

arising from the decline in value of its promissory notes (see

note 7, supra), and the Court of Appeals affirmed the District

Court’s decision in favor of the government on that issue.

Although petitioner believes that the Courts below erred with

respect to that issue, petitioner has concluded that that issue

is not of sufficiently general importance to warrant this Court’s

review.

that “sections 901 through 905 of the Code are unhelpful in

deciding which . . . sourcing rule[s] should be applied”

(App. B, infra, p. B-12), but it held that the newly promul-

gated regulations “provide[s] [the] answer to this ques-

tion” (id.). The Court accorded the new regulation the pre-

sumption of validity (id., at B-27 to B-28), decided that the

regulation was intended to have retroactive application

(id., at B-13 to B-15), and determined that the issuance of a

retroactive regulation to resolve a legal question at issue in

pending litigation was not an abuse of discretion or an

improper exercise of the power to promulgate regulations

(id., at B-15 to B-24).

The Court of Appeals acknowledged that the rule set

forth in the new regulation had “disadvantages” (id., at

B-31, n.32), but it concluded that “the proper dividend

sourcing rule represents a policy choice that Congress has

delegated to the Secretary, not the courts, and we decline

to upset his considered choice” (id.). In so holding, the

Court explicity rejected as “incorrect” (id., at B-17, n.18)

the rule of Commissioner v. Goodwyn Crockery Co., 315

F.2d 110, 113 (6th Cir. 1963), that a Treasury regulation

may not be applied retroactively to a case that was sub

judice at the time the regulation was promulgated.

Since the Court of Appeals also rejected petitioner’s

argument that the Treasury regulations previously in effect

for the taxable year had required the method of computing

the per-country limitation employed by petitioner (App. B,

infra, pp. B-23 to B-24, n.26), the Court found inapplicable

this Court’s admonition in Helvering v. R. J. Reynolds

Tobacco Co., 306 U.S. 110, 116 (1939), that the Secretary of

Treasury lacks power to issue retroactive regulations that

would modify or repeal settled law (App. B, infra, p. B-17

to B-18, B-24 to B-26).

REASONS FOR GRANTING REVIEW

1. This case presents a question of substantial impor-

tance to the litigation of federal tax cases, and indeed a

question of substantial importance to the litigation of all

cases involving federal regulatory issues. The decision be-

low, by permitting the government’s power to promulgate

retroactive Treasury regulations to be used as a successful

litigating ploy, improperly enlarges the Secretary’s power

to make law retroactively and distorts the process by which

disputes between taxpayers and the government are re-

solved. Cf. Central Illinois Public Service Co. v. United

States, No. 76-1058, decided February 28, 1978 (concurring

opinions of Mr. Justice Brennan and Mr. Justice Powell).

The Court’s holding that an administrative agency in effect

can legislate the appellate reversal of adverse district court

decisions has obvious and significant implications for both

tax and non-tax controversies.

The decision of the Court of Appeals, which appears to

be the first to reverse a district court’s judgment in favor

of a taxpayer solely upon the basis of Treasury regulations

that were promulgated while the case was pending on

appeal,’° directly conflicts with the Sixth Circuit’s decision

in Commissioner v. Goodwyn Crockery Co., supra, and also

conflicts in principle with the Second Circuit’s decision in

Chock Full O’ Nuts Corp. v. United States, 453 F.2d 300

(1971). This Court should grant review in order to resolve

this conflict among the Courts of Appeals and to settle an

important issue of federal law.

a. The Court of Appeals below, in considering the under-

lying substantive tax issue that has divided petitioner and

10Newly promulgated regulations were given retroactive appli-

eation in United States v. California Portland Cement Co., 413

F.2d 161 (9th Cir. 1969), but those regulations were viewed

by the Court in that case as merely confirming and codifying

existing case law.

the government from the outset of this litigation, improper-

ly relied upon a Treasury regulation that was promulgated

only after that issue had been resolved in petitioner’s favor

by the District Court. The Court of Appeals should have

disregarded the newly promulgated regulation and looked

solely to the statute and pre-existing regulations in adjudi-

cating this tax case.

This has been the approach taken by other courts of

appeals in like circumstances. In Commissioner v. Goodwyn

Crockery Co., supra, the taxpayer had prevailed in the Tax

Court only to have the Secretary of Treasury promulgate

regulations the apparent effect of which, if enforced and

applied retroactively, would have been to require reversal

on appeal. The Sixth Circuit refused to give such effect

to the new regulations, however, holding instead that since

those regulations had not been in force “at the time of

the hearing, they have no binding force here.” 315 F.2d at

113.1! The Court proceeded to consider the case on the basis

of the statute and regulations in effect at the time the action

had been instituted, and it affirmed the Tax Court’s decision

in favor of the taxpayer.

11 The Court of Appeals below misread the opinion in Goodwyn

Crockery as setting forth the broad proposition that Treasury

regulations may not be given retroactive effect. It was on the

basis of that misreading that the Court concluded that the

holding in Goodwyn Crockery had been rejected by the Eighth

Cireuit in Exel Corp. v. United States, 451 F.2d 80 (1971),

and was contrary to both section 7805(b) of the Internal Reve-

nue Code and this Court’s decision in Dizon v. United States,

381 U.S. 68 (1965) (App. B, infra, p. B-17, n. 18). But the

decision in Goodwyn Crockery does not call into question the

general authority of the Secretary to promulgate retroactive

regulations. Instead, as the Second Circuit correctly explained

in Chock Full O’ Nuts Corp. v. United States, supra 452 F.2d at

302-303, n.6, the rule of Goodwyn Crockery is that the “courts

... [will] decline[] to give retroactive effect to regulations or

rulings of the Commissioner . . . when litigation involving the

area clarified by the regulation had already begun. .. .” Since

Similarly, in the like case of Chock Full O’ Nuts Corp.

v. United States, supra, 453 F.2d at 303, the Second Circuit

observed that “the Commissioner may not take advantage

of his power to promulgate retroactive regulations during

the course of a litigation for the purpose of providing him-

self with a defense based on the presumption of validity

accorded to such regulations.” As in Goodwyn Crockery,

the Court then proceeded to decide the case without regard

to the newly promulgated regulation.!?

The approach followed by the courts in Goodwyn Crock-

ery and Chock Full O’ Nuts is necessary to preserve the

integrity of the rulemaking process. If the Secretary were

empowered to alter the outcome of cases sub judice through

post hoc rulemaking, the issuance of Treasury regulations,

which should represent an expert assessment of the appro-

priate means of effectuating legislative intent, could degen-

erate into little more than a self-serving device of revenue

maximization."® The existence of power to determine the

outcome of pending tax litigation through the issuance of

Treasury regulations would threaten to inject into the

rulemaking process improper considerations of expediency

the issue in both Exel Corp. and Dizon pertained only to the

general authority to promulgate retroactive regulations and

did not concern the question of the effect to be given to newly

promulgated regulations in cases already sub judice, the Court

below erred in treating those decisions as contrary to Goodwyn

Crockery.

12 The Court ultimately concluded that the government’s position

was sustained by the statute and regulations in effect at the

time suit was brought. For this reason, the Court below char-

acterized as dicta the above-quoted passage from the opinion in

Chock Full O’ Nuts. But although the Second Circuit’s view of

the scope of retroactive rulemaking power may not have deter-

mined the outcome of that case, it nevertheless shaped the

way in which the Court reached that outcome.

18 This risk is especially acute where, as in this case, the repeal

of the underlying statute has deprived the new reguiation of

any significant prospective effect. See note 2, supra.

and litigating strategy. Treasury regulations should not be,

and should not appear to be, influenced by such considera-

tions. Accordingly, section 7805(b) of the Code, which gen-

erally authorizes the promulgation of retroactive regula-

tions, should not be construed to allow the Secretary to

prescribe substantive rules to govern matters already be-

fore the courts.’

Once litigation commences with respect to transactions

completed in a prior taxable year, the Secretary should be

deemed to be without power to prescribe new rules to govern

those transactions.’® It is especially unfair to expose a tax-

payer to the hazards and substantial expense of litigation

but then to permit the government, when it has lost in the

trial court, to establish new rules retroactively by adminis-

trative fiat and secure appellate reversal on that basis.

14 Judicial refusal to apply Treasury regulations retroactively to

pending litigation does not adversely affect federal tax enforce-

ment. Tax litigation arises only after the tax return has been

filed and audited by the Internal Revenue Service and, ordi-

narily, after lengthy administrative proceedings have failed to

resolve disputed issues. As a consequence, normally several

years will have passed before-an action is brought in court.

For example, the complaint in this case, which involves peti-

tioner’s taxable year ending July 31, 1964, was filed in 1972

(R. 2). Thus, ample opportunity exists for the Secretary to

promulgate regulations for a past taxable year before the

commencement of litigation involving that year.

15 To permit such retroactive application would allow the Internal

Revenue Service to have its cake and eat it too. Consider, for

example, what the situation would have been had petitioner cal-

culated the per-country limitation on its foreign tax credit by

looking solely to the countries in which its subsidiaries were

incorporated, 1.e., in the manner now advocated by the Service:

in those circumstances, the Service could have argued that the

then-existing regulations (see pp. 4-5, swpra) required peti-

tioner to look instead to the countries in which the income was

earned (as petitioner in fact did in this case), and there can be

little doubt that a reviewing court would have been constrained

to follow that administrative construction of those regulations.

b. At a minimum, the courts should deny to such post hoc

rulemaking the usual presumption of validity. That pre-

sumption rests upon the premise that the agency, in issuing

regulations, is acting as a neutral expert in the explication

of legislative purpose, not as an engaged adversary in a

dispute over specific tax liabilities. Cf. Fribourg Navigation

Co. v. Commissioner, 383 U.S. 272 (1966). That premise fails

where, as here, a regulation may well have been promulgated

at least in part as a bootstrap effort to improve the govern-

ment’s chance of success in pending litigation.

In such circumstances, a new regulation carries with it

the suggestion of improper motivation and gives the ap-

pearance of having been based upon little more than a eal-

culation of where the government’s immediate revenue

advantage lies. Accordingly, there is no reason for a court

to accord substantial deference to a regulation promulgated

pendente lite. If a Treasury regulation is entitled to judicial

consideration at all in tax cases that were sub judice at the

time of promulgation, and we submit that it is not, as a pre-

requisite for such consideration the government should be

required to prove not just that the regulation “is not ‘plainly

inconsistent’ with the Code” (App. B, infra, p. B-32) but

also that it is the preferable method of effectuating the

underlying congressional intent.

2. The retroactive application of the newly promulgated

regulation in this case also was contrary to the precept that

“Congress did not intend to authorize the Treasury to repeal

the rule of law that existed during the period for which the

tax is imposed.” Helvering v. R.J. Reynolds Tobacco Co.,

supra, 306 U.S. at 116. The Court of Appeals acknowledged

that it would be improper for the Secretary to try “to

change settled law at the eleventh hour in order to defend

against [a] taxpayer’s claim” (App. B, infra, p. B-17). The

Court, however, erroneously concluded that the statute and

the regulations in existence at the time this litigation began

had provided no clear guidance with respect to the method

of determining the source of income for purposes of comput-

ing the per-country limitation on the foreign tax credit and

therefore that the promulgation of Treas. Reg. § 1.902-3

(d)(1) (1975) did not represent an effort to “change settled

law.”

Before promulgation of Treas. Reg. § 1.902-3(d) (1)

(1975), it was clear that the source of income, for the pur-

pose of applying the per-country limitation, was the coun-

try in which the income had been earned. As we have ex-

plained above (pp. 4-5, supra), Treas. Reg. § 1.901-2(d)

(1957), had provided that the determination of the source

of income was governed by the principles of sections 861

through 864 of the Code and the regulations thereunder.

Application of those provisions mutatis mutandis demon-

strates that the sources of the distribution from Lausanne

in this case were the countries where the income was earned.

See Treas. Reg. § 1-863-6 (1957); Rev. Rul. 76-535, supra;

Rev. Rul. 77-86, supra. In short, the rule applicable to this

case was “settled” at the time petitioner filed its amended

tax return electing to compute.its foreign tax credit under

the per-country limitation and at the time this litigation

began, and the Secretary lacked power thereafter to repeal

the rule retroactively. Helvering v. R.J. Reynolds Tobacco

Co., supra. See also Central Illinois Public Service Co, v.

United States, supra.

CONCLUSION

The petition for a writ of certiorari should be granted.

March 1978.

Respectfully submitted,

C. W. WELLEN

Sreven C. SaLon

Cuar.es EK, Suu.ivan, JR.

Fulbright & Jaworski

800 Bank of the Southwest

Building

Houston, Texas 77002

Keiru A, Jones

Fulbright & Jaworski

1150 Connecticut Avenue, N.W.

Washington, D.C. 20036

APPENDIX

A-1

[601]

APPENDIX A

OPINION OF THE UNITED STATES

DISTRICT COURT

For Tue SoutHern District or Texas,

NoveMBER 21, 1974

Anperson, CLayton & Co.

Vv.

Unitep Srates or AMERICA.

Crviz Action No. 72-H-188.

Unirep States Disrricr Court,

SourHern District Texas, Houston Drvision.

Nov. 21, 1974.

[602]

C. W. Wellen, Charles W. Hall, Steven C. Salch, Ful-

bright & Jaworski, Houston, Tex., for plaintiff.

Mary Sinderson, Asst. U. S. Atty., Houston, Texas.,

for defendant.

Memorandum Opinion:

SINGLETON, District Judge.

This action is brought for the recovery of internal revenue

taxes and other sums assessed and collected by the Gov-

ernment. Jurisdiction of the action is conferred by 28

U.S.C. § 1346.

A-2

[603]

The case has been submitted to the court on stipulations

of facts and briefs on the law, and the court has made its

determinations upon these.

Anderson, Clayton is a corporation organized and exist-

ing under the laws of Delaware, with certificate of authority

to transact business in Texas and has its domicile and

principal place of business in Houston. It is a large, widely-

held, publicly-owned corporation whose business activities

and those of its subsidiaries are numerous, international

in scope, and include merchandising of cotton, coffee, vege-

table oils and other commodities, financing of various

crops, manufacturing and sale of consumer and animal

food products, warehousing and storage, and insurance

among other things.

This case concerns various complications arising from the

actions of Anderson, Clayton in seeking to utilize Subpart

F of the Internal Revenue Code of 1954 (26 U.S.C. §§ 951-

964) and the foreign tax credit provisions of the code (26

U.S.C. § 904 et seq.).

Of the three issues which were presented to the court

for determination on stipulation, two remain. The issue of

the propriety of plaintiff's claim for direct foreign tax

credit for $159,070.03 paid in Mexican taxes for dividends

received from its Mexican subsidiaries has been disposed

of. Government in Third Stipulation, 17(c) conceded that

plaintiff is entitled to direct foreign tax credit equal to the

entire amount of such tax paid with respect to amounts

distributed as dividends by the Mexican subsidiaries in

fiscal 1964.

Therefore, because it is undisputed that plaintiff was

entitled to direct foreign tax credit under section 901 of

the Internal Revenue Code of 1954 with respect to dividends

A-3

received from its Mexican subsidiaries in its taxable year

ended July 31, 1964, the court finds for the plaintiff on this

question.

The first of the two remaining questions is whether

or not, for purposes of computing the limitations upon

the plaintiff’s allowable foreign tax credit for fiscal 1964

under section 904(a)(1) of the code, attributable to the

$4,684,233.96 minimum distribution to plaintiff by Laus-

anne :! (1) was at least $13,659.00 of the minimum distribu-

tion attributable to foreign base company sales income

earned by its Swiss subsidiary, Lausanne, derived from

sources within Argentina, (2) was at least $3,223,290.00

of such minimum distribution, attributable to foreign base

company sales income earned by Lausanne, derived from

sources within Brazil, and (3) was at least $15,517.49 of

such minimum distributions attributable to foreign base

company sales income earned by Lausanne, derived from

sources within Peru.

Subpart F was added to the Internal Revenue Code of

1954 effective October 16, 1962. It was designed to deal

with United States taxpayers who owned controlling in-

terests in foreign corporations and utilized those corpora-

tions to abuse the foreign tax credit laws. Under Subpart

F the United States shareholder of a controlled foreign

corporation is required to report as its own income “Sub-

part F Income.” For purposes of this case Subpart F' in-

come consisted of “foreign base company income,” 1%. @.,

income earned by the controlled foreign corporation outside

of the country under whose laws it was organized. The

United States taxpayer can reduce or eliminate its Sub-

part F income under the provisions of section 963 of the

1“Tausanne” refers to Anderson, Clayton & Co., 8. A., Anderson

Clayton’s Swiss subsidiary.

A-4

code by electing to have the controlled foreign corporation

make what is called a “minimum distribution” of its earn-

ings and profits to its United States shareholders. In this

case, the United States shareholder would report the mini-

mum distribution as dividend income in place of the Sub-

part F' income which it would otherwise be required to

report.

Plaintiff reported for federal tax purposes for the fiscal

year 1964 a minimum distribution of $4,684,233.96 from

its Swiss subsidiary, Lausanne. Lau-

[604]

sanne had purchased during fiscal 1964 commodities grown

or produced within Argentina, Brazil, and Peru from An-

derson, Clayton subsidiaries domiciled in those countries.

These commodities were resold by Lausanne in those coun-

tries to plaintiff at arm’s length transactions and to un-

affiliated customers at the market price prevailing at the

time. From these sales Lausanne realized income of $4,344-

186.31 as a result of purchases and sales of other income

in Brazil, $65,213.90 from Argentina, and $19,984.23 from

Peru. Lausanne realized during that year $1,614,219.27 in

income from other sources.

When it computed the per-country limitation on its

foreign tax credits, however, the plaintiff treated $3,233,-

293.00 of the minimum distribution which it had reported as

income from Lausanne, as income sourced in Brazil. In the

same way, $13,659.00 of the minimum distribution was

treated as sourced in Argentina and $16,842.00 of the mini-

mum distribution as sourced in Peru. The Government con-

eluded that all of the distribution from Lausanne reported

on its fiscal 1964 tax return should be considered as income

from Switzerland, the country of Lausanne’s incorporation,

A-5

when applying the per-country limitation on foreign tax

credits as provided in Section 904(a)(1) of the Code.?

The plaintiff is seeking to show that the funds have their

true source in Peru, Argentina, and Brazil, respectively,

since Lausanne bought the commodities in those countries

and then resold them there. Each party agrees that of the

minimum distribution at least $13,659.00 came from Argen-

tine products ; $3,223,290.00 came from Brazilian products ;

and $15,517.49 came from Peruvian products. What is in

dispute is the source of the funds as they came from Lau-

sanne to Anderson, Clayton, for purposes of figuring Ander-

son, Clayton’s foreign tax credit limitation. The limitation

is figured by a formula which divides the amount of income

from sources within the foreign country by the taxpayer’s

entire income and then multiplies that figure by the taxpay-

er’s United States income tax liability.

There is no dispute here over the amount of tax paid by

the plaintiff and subsidiaries to Argentina, Brazil, and

Peru. The dispute concerns the legal source of the income,

whether Argentina, Brazil, Peru, or Switzerland. Lausanne

paid taxes to Switzerland. The South American subsidiaries

paid taxes to the South American countries. Lausanne did

not pay taxes to the South American countries on the income

from the sales of the commodities which it bought in those

countries and then sold.

Section 904 of the code provides the method in which the

amount of foreign tax credit allowable is to be determined.

Section 905(b) provides:

The credits provided in this subpart [§§ 901-905 of

this title] shall be allowed only if the taxpayer estab-

2In order to compute foreign tax credit, the Government gives

the company two choices. Anderson, Clayton chose § 904(a) (1)

of the Code, the per-country limitation.

iliac eae

A-6

lishes to the satisfaction of the Secretary or his dele-

gate—

(1) the total amount of income derived from sources

without the United States, determined as provided in

part I [§§ 861-864 of this title],

(2) the amount of income derived from each country,

the tax paid or accrued to which is claimed as a credit

under this subpart [$4 901-905 of this title, such amount

to be determined under regulations prescribed by the

Secretary or his delegate, and

(3) all other information necessary for the verifica-

tion and computation of such credits.

Although Section 905(b)(2) of the Code provides that the

source of income is to be determined under regulations

promulgated by the Treasury Secretary no formal regula-

tion exists which solves the problems presented by the in-

stant case. Defendant contends that the prop-

[605]

er treasury regulation to be considered is § 1.902-1(c)

(1957).* This provision, in essence, determines the source

of income as the place in which the foreign corporation re-

ceiving the income is incorporated,

Plaintiff relies upon the fact that the 1962 Revenue Act

modified the foreign tax credit sections of the code. Regula-

tion 1.902-5(a) (1965) governs here and provides that para-

graphs (a) through (e) of Treas.Reg. 1.902-1 shall not ap-

ply, and that Treas.Regs. 1.902-3 and 1.902-4 shall apply to

8 This regulation provides :

1.902-1 (c) Source of income of foreign subsidiaries and country

to which tax is deemed to have been paid. For the purpose of

section 904(a)(1) (relating to the per-country limitation),

dividends of a foreign corporation (at least 10 percent of whose

voting stock is owned by a domestic corporation) shall be

deemed to have been derived from sources within the foreign

A.7

the years covered by the Revenue Act of 1962. From this

plaintiff concludes (1) plaintiff’s fiscal 1964 was covered

by the Revenue Act of 1962, (2) under § 963 of the code,

the minimum distribution was composed of a portion of

Lausanne’s earnings and profits from 1964, (3) pursuant to

Treas.Reg. 1.902-5(a) (1965), Treas.Reg. 1.902-3 and 1.902-4

are applicable, and (4) Treas.Reg. 1.902-1(c) is inapplicable

to the minimum distribution received in fiscal 1964.

It is undisputed that Treas.Reg. 1.902-3 and 1.902-4

(1965) do not contain a provision comparable to the source

of income provision of § 1.902-1(¢c) (1957) above, which

holds that the country of incorporation is the source. Rath-

er, 1.902-3(d) (1) contains the reference “[Reserved].” The

applicable treasury regulations under § 902 are silent on

how the source is to be determined.

Although the government does not dispute that the trea-

sury regulations under § 902 are silent on this question,

the government contends that the plaintiff places undue em-

phasis on this fact. Proposed Treas.Reg. 1.902-3(d) (1) car-

ries forward the idea of source as the place of incorpora-

tion. Apparently 1.902-1(c) was repealed with a view to

the promulgation of new rules to govern the new situations

created by the 1962 act adding Subpart F’. However, nothing

comparable to the regulation was later promulgated, The

intention of the Treasury Department to continue using the

rationale the Government relies upon, however, is expressed

in T.D. 6805, 1965-1 Cum.Bull. 38 in which the Internal

Revenue Service announced that the proposed regulation

would be reissued. Yet, the regulation has never been re-

issued.

country or possession of the United States in which such foreign

corporation is incorporated, to the extent that under section

862(a)(2) such dividends are treated as income from sources

without the United States.

A-8

The plaintiff contends that there exist basic statutory

rules elsewhere in the code for making the determinations

of income sources and plaintiff’s position is but an appli-

eation of these. Anderson, Clayton proposes that in the

absence of this repealed regulation the Internal Revenue

Service go back to its general rule on determining source

which is found in Treas.Reg. 1.861-7 implementing § 861

of the code:

(a) General. Gains, profits, and income derived from

the purchase and sale of personal property shall be

treated as derived entirely from the country in which

the property is sold.

* * * *

(Section 861 and following), subchapter N, chapter 1

of the Code, and the regulations thereunder, a sale of

personal property is consummated at the time when,

and the place where, the rights, title, and interest of

the seller in the property are transferred to the buy-

The Government makes many legal and moral arguments

for its position. The most compelling argument is one which

attempts to show how Anderson, Clayton is trying to avoid

the “tax-haven” provisions of Subpart F by claim-

[606]

ing that the income was from Switzerland. Section 904(a)

of the code establishes the limitations on a tax credit for

foreign taxes. The taxpayer may elect either an “overall

limitation” or a “per-country limitation.” Anderson, Clay-

ton elected a per-country limitation. This limitation re-

stricts a taxpayer’s foreign tax credit to a percentage of

its United States taxes equal to the proportion which the

taxpayer’s taxable income from the particular country

bears to his entire taxable income from all sources, as we

A-9

have seen. If he reports more taxable income from sources

within those countries which levy income taxes at a rela-

tively high tax rate, the taxpayer stands to gain a greater

foreign tax credit benefit, percentagewise. The Govern-

ment alleges that Anderson, Clayton has attempted to do

just this since Argentina, Brazil, and Peru have higher

tax rates than Switzerland. The Government argues that

this would defeat the congressional intent in passing Sub-

part F. Although later in its brief the Government points

out that in actual recoverable tax dollars in this case it

would not lose that much (a position apparently refuted

by the plaintiff’s reply brief, on pages 16 and 17), the

Government’s efforts are directed toward “avoiding a

strained and illogical application of the foreign tax credit

provisions of the Code and Regulations.” Defendant’s

brief, p. 24.

The plaintiff does not really answer the question pre-

sented by the Government, but points out that the examples

used create a false impression of the case as it exists here.

The plaintiff's argument is that under United States v.

Balinovski, 236 F.2d 289 (2d Cir. 1956), cert. denied, 325

U.S. 968, 77 S.Ct. 357, 1 L.Ed.2d 322 and Treas. Reg.

§ 1.861-7, the source of income derived from the sale of

personal property is the place where title to the property

is passed. Since the parties have stipulated that the title

to the property in question passed in Argentina, Brazil,

and Peru, respectively, the plaintiff argues that it is the

Government which is “converting” Argentine, Peruvian,

and Brazilian source income into Swiss source income, not

Anderson, Clayton which is converting Swiss source in-

come into South American income.

[1] The plaintiff’s and the Government’s arguments on

the logical and moral issues are intended to buttress the

basic arguments of each, but do little more than cloud the

A-10

issues. The basic decision to be made is whether or not to

utilize the Government’s rationale for source of income,

which through inadvertence or design has never been offi-

cially reenacted in the regulations, or to utilize the plain-

tiff’s resort to the general statute to determine the “source”

of the income. The court believes that the Secretary of

the Treasury should reenact its regulation if it is to be

followed by a court. Accordingly, the court finds that

plaintiff is entitled to judgment as a matter of law from the

undisputed facts in this case that, for the purposes of

computing the limitations upon plaintiff’s allowable foreign

tax credit, of the $4,484,233.96 minimum distribution to

plaintiff by its Swiss subsidiary, Anderson, Clayton & Co.,

S.A. (“Lausanne”), in fiscal 1964: (a) $13,659.00 there-

of was derived from sources within Argentina, (b)

$3,223,290.00 thereof was derived from sources within

Brazil, and (c) $15,517.49 thereof was derived from sources

within Peru.

The second question left for the court’s determination

also involves ‘the foreign tax credit limitation provided

by the code. The plaintiff, during fiscal 1964 became

entitled to receive dividends declared by its Argentine

subsidiaries. However, at the time the dividends were to

be distributed, the Argentine currency was blocked by

orders of the Argentine government. Because the Argentine

peso was blocked, plaintiff received the dividend distribu-

tion in the form of negotiable promissory notes payable

to the order of plaintiff in Argentine pesos. Plaintiff then

converted the principal amount of the notes into United

States dollars at the rate of ex-

[607]

change prevailing at the date of distribution and included

the notes in its gross income as a dividend in the amount of

$1,150,320.87. In order to compute the limitations on its

A-11

allowable foreign tax credit for fiscal 1964, the plaintiff

reported the amount of the dividend in its gross income, as

constituting income from sources within Argentina. At the

end of fiscal 1964 plaintiff determined the United States

dollar value of the promissory notes to be $871,428.59, by

applying the then prevailing exchange rates and deducted

the $278,892.29 diminution in value of the notes as an

ordinary business loss. Because the notes were held by

plaintiff within the United States at all times during fiscal

1964 after the date of their receipt, the plaintiff re-

ported the amount of the loss as constituting a loss from

sources within the United States for the purposes of com-

puting the limitations upon the amount of its foreign tax

credit for fiscal 1964. When the plaintiff’s return was ex-

amined, however, the Government determined that if the

plaintiff had actually realized any deductible loss as a result

of the exchange rate decline, which it denies now, such a

loss was an Argentine source loss which had to be treated as

such in computing the foreign tax credit to which plaintiff

was entitled as a result of tax levied by the Argentine gov-

ernment.

The Governmert’s first allegation, then, is that the plain-

tiff did not realize a deductible loss of $278,892.29 during

the fiscal year ending July 31, 1964, as a result of the

decline in value of the promissory notes received as divi-

dends from its Argentine subsidiary in fiscal 1964.

The plaintiff contends that the Government is barred

from raising an issue as to the propriety of the claimed ex-

change loss because the Government failed to raise the

issue by means of a counterclaim or defense by way of offset

against any refund, to which the court may conclude the

plaintiff is entitled.

The Government relies upon language in United States v.

Pfeister, 205 F. 2d 538, 542 (8th Cir. 1953) :

A-12

The validity of any deduction claimed by the taxpayer

in his income tax return is inevitably in issue in his ac-

tion to recover alleged overpayments of income tax.

The Eighth Cireuit goes on to repeat a quotation found in

Lewis v. Reynolds, 284 U.S. 281, 283, 52 S.Ct. 145, 76 L.Ed.

293 (1932) :

[T]he ultimate question presented for decision, upon a

claim for refund, is whether the taxpayer has overpaid

his tax. This involves a redetermination of the entire

tax liability. While no new assessment can be made,

after the bar of the statute has fallen, the taxpayer,

nevertheless, is not entitled to a refund unless he has

overpaid his tax. The action to recover on a claim for

refund is in the nature of an action for money had and

received, and it is incumbent upon the claimant to show

that the United States has money which belongs to him.

Lewis v. Reynolds, 48 F.2d 515, 516 (10th Cir. 1931).

The conclusion which the Eighth Circuit reached was that

if the evidence raises a question of the legality or amount of

a claimed deduction in an action to recover an overpayment

of taxes, there is‘an issue raised for purposes of defense

regardless of its availability as an affirmative remedy.

[2] The court, agreeing with the Eighth Cireuit, does

not believe that there is any necessity for the Government to

plead its contentions in a counterclaim or offset against a

refund because the Government is not attempting to assert

a separate liability in avoidance of the claim, but it only

challenges the allegation that plaintiff has paid too much

in taxes for fiscal 1964. Nor does the court agree with the

plaintiff -that the plaintiff has been deprived of an op-

portunity to fairly meet the defendant’s

[608]

contentions. The court concludes the issue is properly before

the court.

A-13

[3, 4] The Government’s first contention is that the

plaintiff did not realize a deductible loss of $278,892.29 dur-

ing the fiscal year ending July 31, 1964, as a result of the

decline in value of the promissory notes received as divi-

dends from its Argentine subsidiary because the plaintiff

could not realize a deductible loss from the mere decline in

value of the notes receivable which it had caused its Argen-

tine subsidiaries to issue. The general and well established

rule is that “a mere decline, diminution or shrinkage of the

value of property does not constitute a deductible loss.” 5

Mertens, Law of Federal Income Taxation (Rev.) § 28.14.

The rule is applicable to all forms of property, from ships

to building and loan shares. Mertens, supra at n. 61. Before

a deductible loss can be claimed, the property must be sold,

abandoned, or discarded, or there must be a demonstration

of complete worthlessness.

[5] In the specific area of fluctuations in the value of

foreign currency, the rule, for the most part, holds true, and

“mere shrinkage in the value of foreign money is not

enough to permit a deduction for a loss sustained.” Mer-

tens, supra at § 28.82. When losses are allowed, they are

allowed only at the time foreign currency is converted into

dollars. Mertens, supra.

In the instant case the peso notes had not been ex-

changed for United States dollars at the end of the fiscal

year, so no deductible loss had been realized under the

general rule.

Without arguing this point, Anderson, Clayton’s reply to

the Government’s position is that the defendant is collater-

ally estopped from denying that plaintiff is entitled to claim

the loss in fiscal 1964. In the 1930’s the plaintiff maintained

branch offices in Alexandria, Egypt, and Havre, France,

among other places. The profits of these branches were

figured by adjusting the current accounts on the books of

A-14

the branch offices to the dollar values at the close of each

fiscal year. The amounts in dollar value were then carried

over to the home office account and were reported as income

for United States tax purposes. The Internal Revenue Ser-

vice challenged this accounting method for the years 1933

and 1934 and suit was brought in the United States tax

court. The plaintiff and the Commissioner eventually settled

the case and reached an agreement which allowed Anderson,

Clayton to keep the accounts of its autonomous foreign

offices in foreign currency and to determine the income of

these branches by figuring the difference in dollar net worth

at the beginning and the end of the year, adjusting for any

profits transferred from the branch during the year. This

accounting practice was challenged again in the Court of

Claims for certain claims made in the years during World

War II. The Court of Claims handed down its decision in

the case in 1958. The Court of Claims held that the plaintiff

was entitled to a loss deduction for exchange losses deter-

mined under its accounting practice with respect to all pay-

ables from foreign branches, subsidiaries, or unrelated en-

tities for which the plaintiff had a tax basis. Anderson,

Clayton & Co. v. United States, 144 Ct.Cl. 106, 168 F.Supp.

452 (1958).

The plaintiff’s position is that there is an identity of is-

sues in that case and the instant case, and that the controll-

ing facts and applicable legal rules have not changed since

1958.4 The plaintiff points out that the parties to the 1958

Court of Claims case are identical to those now before the

court and the matter at issue before the Court of Claims

[609]

4 Plaintiff cites Commissioner v. Sunnen, 333 U.S. 591, 68 S.Ct.

715, 92 L.Ed. 898 (1948) in which the Supreme Court stated

the requirements for collateral estoppel in tax controversies

ir’ lving different tax years: (1) identity of issues and (2)

tu. absence of change in controlling facts and applicable legal

rules. 333 U.S. at 599-600, 68 S.Ct. 715.

A-15

in the 1958 case was the propriety of the deduction of an

exchange loss upon receivables from plaintiff's Egyptian

subsidiary, which was held by the plaintiff. The issue the

defendant raises in the instant case involves the propriety

of the deduction of an exchange loss upon receivables of

plaintiff’s Argentine subsidiaries which were held by plain-

tiff. Plaintiff further points out that the controlling facts

involve plaintiff’s long established accounting practice con-

cerning exchange fluctuations upon its receivables from

and payables to foreign subsidiaries as well as foreign

branches and unrelated entities which have not varied in

substance since 1930 and which have been accepted and

approved by the Government, except with respect to items

in which the plaintiff had no tax basis, at least since 1958.°

Pursuant to Anderson, Clayton & Co. v. United States,

supra, the plaintiff realized and properly claimed a deduc-

tion for fiscal 1964 for the $278,893.29 exchange loss sus-

tained in fiscal 1964, as the plaintiff views the case. In

other words, the plaintiff concludes that the defendant is

collaterally estopped from denying that the plaintiff

realized the exchange loss in fiscal 1964 because of the

decline in United States dollar value of the Argentine

peso between the date of the distribution and the end of

fiscal 1964.

The Government contends that because the controlling

facts in the older cases and the instant case are not the

same, collateral estoppel cannot apply. The Government’s

theory is that prior litigation between the parties was

5 The parties have stipulated:

Plaintiff has consistently maintained an accounting practice of

reflecting at the end of each fiscal year gains and losses from

exchange fluctuations on payables to and receivables from its

foreign subsidiaries and unrelated concerns as well as from its

foreign branches.

Third Stipulation, 10.

A-16

concerned with balancing reciprocal accounts between plain-

tiff and its foreign branch offices through which accounts

the plaintiff's own net operating income was determined.

It argues that the settlement agreement referred only to

foreign branch offices of the parent corporation and not to

foreign subsidiaries which are themselves corporations.

Further, in the instant case, the concern is with the fluctua-

tion in the values of current assets which consisted of

negotiable notes plaintiff received from his foreign subsi-

diaries. The Government points out that the plaintiffs

caused the Argentine subsidiaries to declare the dividends

and also caused the subsidiaries to issue negotiable notes

in the payment of those dividends, even though the cash

payment was prohibited under laws of Argentina. The

plaintiff's voluntary action caused it to receive income,

and nothing in Subpart F of the code required plaintiff to

force the Argentine subsidiaries to declare dividends, or

to issue notes in payment of the dividends. In fact, Sub-

section 964(b) of the Internal Revenue Code of 1954 and

regulations promulgated thereunder provide for situations

in which currency or other restrictions or limitations im-

posed by foreign countries prevent the distribution by the

controlled foreign corporation to the United States stock-

holder for earnings and profits of that controlled foreign

corporation, by in essence exempting corporations faced

with this situation from the Subpart F provisions.

The Government reasons that the agreement between the

parties which terminated the tax court litigation of the

1930’s should be restricted to its intended application, @. e.,

that of determining the correct income earned by plaintiff

through its own foreign branch offices. This application

should not be expanded to encompass declines in value of

dividends issued in the form of negotiable securities which

plaintiff received from separate foreign corporate entities.

A-17

To conclude, the defendant submits that the plaintiff real-

ized no deductible loss, in fiscal 1964, as the result of a

decline in value of the negotiable securities and that the

realization of a loss must wait for plaintiff’s disposition

of the notes.

[610]

Plaintiff, of course, does not agree that the facts are dis-

similar. In the first place, the language of the 1942 agree-

ment entered into between plaintiff and defendant, while not

explicitly including foreign subsidiaries, uses the term

“other autonomous foreign offices,” and the plaintiff asserts

this term is easily susceptible of an interpretation including

corporate foreign subsidiaries. In 1958 the Court of Claims

reviewed the agreement between plaintiff and defendant and

the practices of the plaintiff pursuant to that agreement and

used the agreement in relation to an Egyptian subsidiary

of plaintiff. In the second place the plaintiff points out that

in the specific findings of fact and conclusions of law handed

down by the Court of Claims in the 1958 case, referring to

the settlement agreement the Court of Claims stated that

“pursuant to the above agreement, plaintiff thereafter con-

sistently reflected gains and losses from its exchange fluctu-

ations on accounts payable to or receivable from its foreign

subsidiaries and unrelated concerns as well as from its

foreign branches.” 168 F.Supp. at 543. In the third place,

the foreign entities involved in the exchange loss issues be-

fore the Court of Claims were not only plaintiff’s Alexan-

dria branch office but Niles Ginning Company which was an

Egyptian subsidiary of plaintiff. The exchange losses at

issue in the case were sustained with respect to accounts of

both of those entities. The issue before the Court of Claims

was the propriety of an allowance of a deduction for the

resulting exchange losses sustained by plaintiff under its ac-

A-18

counting methods with respect to the subsidiary’s obliga-

tions to the parent.

Plaintiff argues that the Court of Claims recognized the

propriety of the plaintiff's method of accounting and the

allowance of the exchange loss deduction and inclusion of

exchange gain income realized thereby. The court held,

however, that the defendant could only claim a loss deduc-

tion with respect to the Egyptian subsidiary’s account to

the extent that the plaintiff had a tax basis therein. Ac-

cordingly, they partially disallowed plaintiff’s loss deduc-

tion to the extent that it exceeded plaintiff’s basis in the

subsidiary’s account. The factual account of the way in

which the Egyptian case arose is as follows.

In 1939 after World War II broke out, the Egyptian gov-

ernment clamped controls on the transfer of Egyptian

pounds into United States dollars. This prohibited the plain-

tiff from remitting any profits it might receive at its Egyp-

tian branch to its home office. At the end of the war, fiscal

year July 31, 1945, the plaintiff, after Egyptian taxes, had

net remitted earnings of 128,119,471 Egyptian pounds. All

of this income had been reported as United States income

at the rate of $4.13 to the pound. On July 31, 1945, and after,

until the branch office was liquidated, the plaintiff took

into its United States income for United States tax purposes

the dollar value of its branch office profits. On January 31,

1949, the Alexandria branch office was liquidated and the

Nile Ginning Company took over all of the branch’s assets

and liabilities. On its books in Houston the plaintiff had a

current account receivable of £250,665.745, Egyptian, which

represented blocked funds valued at the then rate of $4.13

to the pound. In September of 1949 Britain devalued the

pound sterling and this resulted in a reduction of the Egyp-

tian pound. On July 31, 1950, the Egyptian pound was worth

only $2.50. The resulting decrease in the plaintiff’s blocked

Egyptian earnings amounted to $413,462.19 and the plain-

A-19

tiff claimed a loss deduction on its fiscal 1950 income tax

return for this amount. The Commissioner denied this claim

on the grounds that the Egyptian account represented

Egyptian income deferred under Mimeograph 6475. This

Mimeograph from the Internal Revenue Service attempted

to deal with the problem of income in currency or other

property situated in foreign countries having monetary or

exchange restrictions. These restrictions made it difficult for

[611]

the taxpayer to ascertain the value in terms of United

States dollars of the blocked income arising in countries

having such restrictions. The plaintiff had utilized this

Mimeograph but it claimed that under the collateral agree-

ment entered into during the 1930’s it should be allowed to

include the exchange fluctuations of its Egyptian account

in determining its 1950 taxable income, notwithstanding

the Mimeograph. The Court of Claims found that:

as set out in the collateral agreement it would be

entitled to include in a loss deduction the deminution of

the dollar value of the Egyptian pound account in the

year 1950. However, when plaintiff elected to come

under the terms of the Mimeograph which permitted

the deferral of blocked income, it, to that extent,

abandoned its former method of accounting and is now

- bound by the terms of the Mimeograph.

To the extent that the plaintiff's Egyptian account repre-

sented earnings for the years 1946-1949, those sums had

never been reported as income and would not be reported

as income until they became unblocked. No deduction was

allowed for the years 1946-1949, but pre-1946 the plaintiff

was entitled to deduct the sum representing the loss claimed

on the tax paid to the United States on the Egyptian

accounts and was entitled to a sum representing the over-

payment.

A-20

The 1934 agreement between the plaintiff and the Com-

missioner, which is set out in Finding of Fact Number 4 in

the 1958 Court of Claims case, Anderson, Clayton v. United

States, supra, is concerned with the question of foreign

branch accounting. The branches and subsidiaries kept

their accounts in foreign currency. Their income, it was

agreed, was to be determined by the difference in dollar

net worth at the beginning and end of the year adjusted for

any profits transferred from the branch during the year.

In order to calculate the dollar net worth the current dollar

rate of the foreign currency involved was used in the case

of all current assets and all liabilities and the dollar value

of fixed assets was to be determined by the original foreign

currency cost converted to dollars at the rates in effect at

the date the investment was made. Transfers of funds

inter-office were to be included at the rates actually used.

The idea was to take into income the fluctuations in net

worth resulting from changes in dollar values of liabilities

and current assets carried in foreign currencies and the

intention was to avoid inclusion in income of changes in

the dollar value of fixed assets and investments as a result

of fluctuation of exchange rates unless and until the assets

were sold or disposed of. Clearly, therefore, the agreement

concerned a method of calculating the income of the tax-

payer Anderson, Clayton. While the law has not changed

with specific regard to the issue and it is stipulated that

the method of figuring income is essentially unchanged, the

government points out that the agreement should be re-

stricted to its intended application. It characterizes this

intended -application as “determining the correct income

earned by the plaintiff through its own foreign branch

offices.”

There are differences between the instant transaction

and the one litigated in 1958. Starting in 1939 the plaintiff

was unable to actually receive the income from its subsi-

A-21

diary because the funds were blocked by the Egyptian

government. The plaintiff reported those earnings accord-

ing to the agreement, however. The earnings went down on

the books in the United States as United States earnings.

Since the Egyptian subsidiary calculated its books on the

Egyptian pound note basis, the United States company

had to put the income down as dollars, and converted the

pounds into dollars at the rate of $4.13. In the years 1939

to 1949 the United States company received only one actual

remittance from Egypt, but it had paid United States

taxes on the money as if it had earned these dollars at

that exchange rate. This practice continued

[612]

until Anderson, Clayton began to employ Mimeograph 5475.

The Mimeograph was considered by the Court of Claims

as an exception to the rule of waiver of the agreement, as

we have seen; so the Court of Claims only allowed Ander-

son, Clayton a recovery for exchange losses for Egyptian

pounds earned prior to August 1, 1945, on which the plain-

tiff had paid United States income tax. In the instant case

the subsidiaries in Argentina declared a dividend (the

government suggests that the parent corporation unneces-

sarily caused the subsidiaries to declare these dividends)

which the subsidiaries could not pay in cash because of

currency blockage. Rather, the subsidiaries issued nego-

tiable promissory notes which then depreciated in value

from date of receipt to the close of the fiscal year.

It is the court’s duty to ascertain whether or not the

agreement of the 1930’s covers the instant case. The facts

are similar in that the Argentine corporation issued security

notes representing income to the parent corporation. The

settlement agreement provided that Anderson, Clayton

could figure its income so that the income of its subsidiaries

A-22

was carried as income of the United States company and

the fluctuations in value by reason of the exchange rate

were figured twice a year and any gains and losses were

accounted for when the taxes were paid on the income.

[6] The court believes that the agreement of the 1930's

should be restricted to its intended use. In the instant case,

the transaction was really not an adjustment of operating

income between parent and foreign holdings (as was in-

tended by the original agreement), but a dividend issued

by the subsidiary to the parent for its own reasons. To the

extent that the Court of Claims allowed in 1958 a loss

deduction for the currency fluctuations of the Egyptian

pound, this court believes that the Court of Claims was

attempting to rectify an unfortunate result of war and

was not intending to set a precedent for future litigation.

Accordingly, the court finds that, applying the general rule,

the plaintiff did not realize a loss of $278,892.29 during

the fiscal year ended July 31, 1964, as a result of the decline

in value of promissory notes which plaintiff received in

fiscal 1964 as dividends from its Argentine subsidiaries.

It has been stipulated [Third Stipulation, 18] that the

plaintiff need not present further evidence of the dollar

amount of any judgment to which it may be entitled by

virtue of a decision of the court favorable in full or in

part to plaintiff. Such amount, if any, will be computed by

defendant in accordance with its normal procedures, and

the right is reserved to plaintiff to have the court recompute

such amount in the event plaintiff should not be satisfied

with defendant’s computation.

Accordingly, the Government is directed to recompute

the plaintiff’s tax in accordance with this court’s findings

and to submit a proposed judgment to the court within

ninety (90) days from the date of the entry of this order.

B-1

[585]

APPENDIX B

OPINION OF THE UNITED STATES COURT OF

APPEALS FOR THE FIFTH CIRCUIT,

NOVEMBER 11, 1977

Anpberson, Ciayton & Co.,

Plaintiff-Appellee-Cross-A ppellant,

Vv.

Unirep States or AMERICA,

Defendant-A ppellant-Cross-A ppellee,

No. 75-2573.

Untrep States Court or AppEALs, Firth Crrcurr.

Nov. 11, 1977.

REHEARING AND REHEARING EN BANC

DENIED DECEMBER 20, 1977

[586]

[587]

Appeals from the United States District Court for the

Southern District of Texas.

Before TUTTLE, GOLDBERG and CLARK, Circuit

Judges.

GOLDBERG, Circuit Judge:

B-2

Anderson, Clayton & Co. (taxpayer) brought this refund

action to recover federal income taxes paid for 1964. Two

discrete tax matters are involved. The first matter involves

determining the geographic source of a minimum distribu-

tion to taxpayer of a foreign subsidiary’s “subpart F

income” for the purpose of computing the per-country

limitation on the foreign tax credit allowed taxpayer under

LR.C. § 904(a)(1).! The second matter concerns promis-

sory notes distributed to taxpayer as dividends by a

foreign subsidiary. The question is whether the taxpayer

realized a deductible loss from the decline in exchange

value of the notes, which were payable in a foreign currency.

The first matter will turn initially on the applicability,

retroactivity, and validity of a treasury regulation govern-

ing the “sourcing” of dividends that was promulgated

after the district court’s decision in this case.? We find the

regulation applicable, retroactive, and valid and reverse the

district court’s judgment for the taxpayer on this issue.

The second matter will turn on the putative collateral

estoppel effect of a Court of Claims decision that, contrary

to accepted tax practice, allowed the taxpayer a loss deduc-

1Subpart F, part III. subchapter N, chapter 1 of the Code,

§§ 951-964 concerns the income of a foreign corporation con-

trolled by a domestic corporation. For purposes of this case, we

may assume that subpart F income is foreign base company

sales income, defined by § 954(d) (1) in pertinent part as income

derived in connection with the purchase of personal property

from a related person and its sale to any person... where —

(A) the property which is purchased .. . is manufactured,

produced, grown, or extracted outside the country under the

laws of which the controlled foreign corporation is created or

organized, and (B) the property is sold for use, consumption,

or disposition outside such foreign country .. ..

As will be explained, infra, taxpayer found it tax beneficial

to receive as a “minimum distribution” or dividend part of a

foreign subsidiary’s subpart F income during fiscal 1964.

2 See note 5, infra.

B-3

tion for the wartime decline in exchange value of foreign

currency holdings that had not been converted into dollars.’

We hold that the government was not collaterally estopped

and affirm the district court’s judgment for the govern-

ment on this issue.

SOURCE OF A MINIMUM DISTRIBUTION

OF SUBPART F INCOME

Taxpayer is a large, widely-held corporation engaged

along with its subsidi-

[588]

aries in activities including the merchandising of cotton,

coffee, and other commodities, financing various crops, and

manufacturing and selling food products. In its income tax

return for fiscal 1964,‘ taxpayer, as authorized by § 963 of

the Code, elected to report as income a minimum distribu-

tion of earnings and profits in the amount of $4,684,233.96

from its Swiss subsidiary, Anderson, Clayton & Co., S. A.

(hereinafter Lausanne). By electing to report the minimum

distribution as income in 1964, the taxpayer avoided the

necessity of reporting as its own income all of Lausanne’s

subpart F income, as otherwise required by § 951(a)(1)(A)

of the Code.

The bulk of Lausanne’s subpart F income for 1964 was

foreign base company sales income derived from sales of

commodities grown or produced within the countries of

Argentina, Brazil, and Peru. Subsidiary corporations of the

8 Anderson, Clayton & Co. v. United States, 168 F.Supp. 542, 144

Ct.Cl. 106 (1958).

4Taxpayer keeps its books and records and files its income tax

returns on the accrual method of accounting as authorized by

LR.C. § 446(c) (2). For the year in question it used an account-

ing period ending July 31.

B-4

taxpayer domiciled in those countries sold the commodities

to Lausanne, which then resold the goods in the countries of

their origin to unaffiliated customers in arms-length trans-

actions.

Lausanne paid no tax on its earnings from these sales to

any of the South American countries in which it transferred

title to the merchandise. It paid tax on the accrued profits

only to Switzerland.

When taxpayer computed its foreign tax credits under the

per-country limitation of §904(a)(1) of the Code, it

treated $13,659 of the minimum distribution as income

sourced in Argentina, $3,233,293 of the minimum distribu-

tion as income sourced in Brazil, and $15,517.49 of the mini-

mum distribution as income sourced in Peru. That Lausanne

earned those amounts in those countries is undisputed. The

Commissioner determined, however, that for the purpose of

computing the per-country limitation on foreign tax credits,

all of the distribution from Lausanne had its source in

Switzerland, the country of Lausanne’s incorporation. On

February 14, 1972, the taxpayer filed a refund action in

district court.

The sole issue is the source for foreign tax credit limita-

tion purposes of those portions of the minimum distribution

from Lausanne that Lausanne earned in Argentina, Brazil,

and Peru, respectively. The taxpayer asserted below that

the distribution should be sourced where the profits compris-

ing it were earned. The government asserted that the distri-

bution should be sourced where the subsidiary that earned

the profits was incorporated.

The district court determined that because the Secretary

of the Treasury had withdrawn and not formally reenacted

a regulation supporting the Commissioner’s position, the

taxpayer was entitled to prevail. The lower court thus failed

to decide whether the sourcing rule proposed by the tax-

B-5

payer or that proposed by the government more faithfully

carried out Congress’s purpose regarding the interplay be-

tween subpart F', which governs the tax treatment of the

foreign source income of a controlled foreign corporation,

and the Code provisions governing the computation of the

foreign tax credit. Rather, the trial court appears to have

taken the position that the government’s failure to issue a

treasury regulation embodying its view left the field open

for taxpayer’s proposed sourcing rule, the merits of which

it left entirely unexamined.

[589]

On October 2, 1975, the Treasury adopted Treas.Reg.

§ 1.902-3(d)(1) (1975), which provides that for purposes

of the per-country limitation of the foreign tax credit, the

dividend received by a domestic shareholder from a first-

tier subsidiary corporation shall be deemed to be derived

from sources within the country in which the first-tier

corporation is incorporated.®

5 Treas.Reg. § 1.902-3(d) (1):

For purposes of section 904(a)(1) (relating to the per-

country limitation), in the case of a dividend received by a

domestic shareholder from a first-tier corporation there shall

be deemed to be derived from sources within the foreign

country or possession of the United States under which the

first-tier corporation is created or organized the sum of the

amounts which under paragraph (a) (3) (ii) of § 1.861-3 are

treated, with respect to such dividend, as income from sources

without the United States.

It is undisputed that taxpayer is a domestic shareholder, mean-

ing for purposes of § 902 a domestic corporation owning at least

10 percent of the voting stock of a foreign corporation, see

Treas.Reg. § 1.902-3(a)(1) (1975), or that Lausanne qualifies

as a first-tier corporation. The sole point of contention regarding

whether Treas.Reg. § 1.902-3(a)(1) addresses the problem at

hand is whether a “minimum distribution” for purposes of § 963

of the Code is a “dividend” for purposes of Treas.Reg.

§ 1.902-3(d) (1). This matter is discussed, infra.

B-6

[1] If Treas.Reg. § 1.902-3(d)(1) does in fact speak to

the point at issue, if it is retroactively applicable to the case

at bar, and if the regulation is valid, then we would no

longer be faced with the question whether as an original

matter the taxpayer’s proposed sourcing rule or the govern-

ment’s rule more faithfully carries out Congress’s purpose

with respect to the interplay between subpart F and the

foreign tax credit provisions. Insofar as the regulation

may be characterized as a legislative rule, it is as binding

on a court as a statute. See Kramertown, Inc. v. Commis-

sioner of Internal Revenue, 488 F.2d 728 (5th Cir. 1974) ;

K. Davis, Administrative Law § 5.03 (3d ed. 1972).®

Before addressing the questions whether Treas.Reg.

y 1.902-3(d)(1) is valid and whether it is retroactively

applicable to the case at bar, we need to place the regula-

tion in the context of the complex statutory scheme regard-

ing the tax treatment of subpart F income.’ After attempt-

® Regulations issued pursuant to a specific statutory authorization

are clearly legislative as opposed to interpretative rules. If con-

sistent with the statutory authorization, adopted pursuant to

proper procedure, and reasonable, they have force of law. See

Fitzgerald Motor Co., Inc. v. Commissioner of Internal Revenue,

508 F.2d 1096 (5th Cir. 1975) ; Posey v. United States, 449 F.2d

228 (5th Cir. 1971). Section 963(f) of the Code provides that

the Secretary shall provide such regulations as he deems neces-

sary regarding the receipt of minimum distributions by domestic

corporations. As the taxpayer asserts, Treas.Reg. § 1.902-3(d)(1)

amends regulations issued under § 963 of the Code and is there-

fore at least in part legislative in nature. See note 17, infra.

7 The recent repeal of the minimum distribution option of § 963 of

the Code means that the issue of the geographic source of sub-

part F income will be unimportant to foreign corporations for

taxable -years beginning after December 31, 1975. Tax Reduction

Act of 1945, Pub.L.No. 94-12, § 602(a)(1) (March 29, 1975).

Similarly, the issue of the geographic source of income from

sources without the United States for purposes of the per-

country limitation upon foreign tax credit has become sub-

stantially moot for taxable years beginning after December 31,

1975, through repeal of § 904(a)(1) of the Code. Tax Reform

Act of 1976, Pub.L.No. 94-455, §§ 1031(a) and (c) (October 4,

1976).

B-7

ing to gain an overview of that scheme and how it relates

to the Code’s provisions regarding the foreign tax credit,

we shall consider whether the regulation applies to the case

at bar.

[590]

II.

Prior to 1962, the foreign source inconie of a foreign

corporation was not subject to United States income tax

until distributed as dividends to its United States share-

holders.® If the domestic shareholder was a corporation, it

was eligible for foreign tax credit. The result was that by

possessing a foreign subsidiary in a low tax country and

deferring the distribution of dividends, a domestic corpora-

tion could thus at least defer taxation of foreign source

income to the extent its foreign taxes were less than those

it would have paid in United States tax. When the subsid-

iary did distribute its income to the parent, United States

tax was imposed only to the extent the United States tax

rate was above that applicable in the foreign country. As

the Congress observed:

In the case of foreign subsidiaries, therefore, this means

that foreign income taxes are paid currently to the

extent of the applicable foreign income tax, and not

until distributions are made will an additional U.S.

tax be imposed, to the extent the U.S. rate is above

that applicable in the foreign country. This latter tax

effect has been referred to as “tax deferral.”

Sen.Rep.No.1881, 87th Cong., 2d Sess. 78, [1962] U.S. Code

Cong. & Admin. News, p. 3381. In his message to Con-

gress in 1961, President Kennedy questioned the wisdom of

8 The rule given in text did not apply to income of a foreign per-

sonal holding company not engaged in a trade or business within

the United States.

B-8

such favorable tax treatment: “The undesirability of con-

tinuing deferral is underscored where deferral has served

as a shelter for tax escape through the unjustifiable use

of tax havens such as Switzerland.” Jd.

In order to eliminate the perceived abuses of its foreign

tax scheme, Congress enacted the provisions of subpart F’.

Revenue Act of 1962, § 12, Pub.L. 87-834, 87th Cong., 2d

Sess. (October 16, 1962). See generally Beemer, Revenue

Act of 1962 and United States Treaty Obligations, 20 Tax

L.Rev. 125 (1964). The central provision of the new legisla-

tion may be summarized as follows: if the subpart F income

of a controlled foreign corporation® exceeds certain limits,

a United States shareholder’? of that foreign corporation

is required to include in his taxable income a pro rata share

of the corporation’s subpart F income, as defined in § 952,

whether or not distributed to him.™

As an ameliorative measure for corporate shareholders

of controlled foreign corporations, Congress also enacted

§ 963. That section provides that subpart F income is not

to be taxed to the domestic corporate shareholder if the

foreign corporation meets a schedule of minimum distribu-

tions. The purpose of this provision is to forego any tax on

the

®For purposes of subpart F, a controlled foreign corporation

means a foreign corporation of which on any day within the

taxable year United States shareholders (see note 9, infra)

own more than 50% of the total combined voting power of all

classes of stock entitled to vote. I.R.C. § 957(a).

10 Section 951(b) of the Code defines “United States shareholder”

to mean, with respect to any foreign corporation, a United

States person who owns actually or constructively 10% or more

of the total combined voting power of all classes of stock of

such corporation entitled to vote.

11 The general class of subpart F income that concerns us in the

case at bar is foreign base company income, as defined in

§ 954(a). More particularly, we are concerned with foreign base

company sales income as defined in § 954(d)(1). See note 1,

supra.

B-9

[591]

domestic shareholders with respect to undistributed in-

come of controlled foreign corporations in cases when the

combined foreign and United States tax (to the extent the

latter is paid on the distributed income) is not substantially

below the United States corporate tax rate. Sen.Rep.No.

1881, 87th Cong., 2d Sess. 88, 1962 U.S. Code Cong. & Admin.

News, p. 3391. Hence the lower the foreign tax rate, the

greater the required minimum distribution. For example,

if the effective foreign tax rate is under 10% a controlled

foreign corporation must distribute 90% of its earnings

and profits after foreign taxes; if the foreign tax rate is

40% the required minimum distribution is 50%. The lower

the foreign tax rate, the higher the proportion of total

earnings must be subject to U.S. tax if the aggregate rate

is not to be substantially below the U.S. corporate rate.

As a condition to using the relief provision offered by

§ 963, a taxpayer is required to consent to all regulations

promulgated under that section that are applicable to the

year in question.’ Treas.Reg. § 1.963—4(c)(1) provides

12 Section 963 provides in part: .

(a) In the case of a United States shareholder which is a

domestic corporation and which consents to all the regulations

prescribed by the Secretary or his delegate under this section

prior to the last day prescribed by law for filing its return of

the tax imposed by this chapter for the taxable year, no amount

shall be included in gross income under section 951(a) (1) (i)

for the taxable year with respect to the subpart F income of a

controlled foreign corporation if —

(1) in the ease of a controlled foreign corporation described

in subsection (c)(1) the United States shareholder receives a

minimum distribution of the earnings and profits for the taxable

year of such controlled foreign corporation ;

+ * * * * *

(f) The Secretary or his delegate shall prescribe such regula-

tions as he may deem necessary to carry out the provisions of

this section, including regulations for the determination of the

amount of foreign tax credit in the case of distributions with

respect to the earnings and profits of two or more foreign

corporations.

B-10

that the foreign tax credit of a United States shareholder

with respect to a minimum distribution received for the

taxable year shall be determined under the provisions of

§§ 901 through 905, subject to certain conditions not rele-

vant here. Hence, questions regarding the treatment for

purposes of the foreign tax credit of § 963 minimum distri-

butions require resort to the interstices of §§ 901 through

905 and their accompanying regulations.

The foreign tax credit provisions, §4 901 through 905,

were enacted in order to eliminate double taxation by ensur-

ing that income subject to tax in the United States and

a foreign country is taxed no more than the higher of either

the United States or foreign country rate. See generally

American Chicle Co. v. United States, 316 U.S. 450, 451, 62

S.Ct. 1144, 1145, 86 L.Ed. 1591 (1942) (construing predeces-

sor statutes). Section 901 provides that a taxpayer is

allowed a credit against his federal income tax for taxes

paid or deemed paid to a foreign country. Under § 902(a),

a domestic corporation with a foreign subsidiary is deemed

to have paid a pro rata portion of any foreign income tax

paid by the foreign subsidiary on distributed earnings.

The portion of taxes deemed paid by the United States

shareholder is an amount that bears the same percentage

relationship to the total taxes paid by the foreign corpora-

tion as the amount of dividends received by the domestic

corporation bears to the total income received by the for-

eign corporation.

[592]

The amount of the foreign tax credit is limited, however,

by the provisions of § 904. For the taxable years in ques-

tion, the Code offered taxpayers the option of computing

the maximum foreign tax credit by either a “per-country”

limitation, I.R.C. § 904(a)(1), or an “overall” limitation,

B-11

ILR.C. § 904(a)(2).1% Under the per-country option, the

credit for any country may not offset a greater share of

the taxpayer’s United States taxes than the earnings

sourced in that country comprise of the taxpayer’s total

earnings.’* Thus, the source of foreign earnings becomes

| crucial in calculating the foreign tax credit.

The only question presented here is the source for this

purpose of the minimum distribution taxpayer received

from Lausanne. Taxpayer would source the income received

in the three South American countries in which Lausanne

earned that income. This would increase the foreign tax

credit allowed taxpayer with respect to those countries and

would enable it to take a larger tax credit for taxes paid

by its subsidiaries in those countries. The government would

source the Lausanne distribution in Switzerland, the coun-

try of that subsidiary’s incorporation, thereby increasing

taxpayer’s maximum foreign tax credit with respect to

Switzerland.

13 For taxable years after December 31, 1975, taxpayers are re-

quired to determine their foreign tax credit limitation on an

overall basis, subject to certain carryover provisions for tax-

payers previously on the per-country limitation basis. See note 7,

supra.

14 This may also be expressed as follows:

Maximum Credit

for tax year for

taxes paid or

deemed paid to

Country C

Taxable Income Received

from Country C

World-Wide Taxable

Income

United States Income Tax on World-Wide

Income (before foreign tax credit)

B-12

III.

[2] Sections 901 through 905 of the Code are unhelpful

in deciding which of these proposed sourcing rules should

be applied.t® By adopting Treas.Reg. § 1.902-3(d)(1), the

Secretary of the Treasury has, we believe, sought to pro-

vide an answer to this question.?®

Taxpayer first asserts that because the regulation refers

only to “dividends” rather than “minimum distributions”

and because a § 963 minimum distribution differs from the

traditional dividend, Treas.Reg. § 1.902-3(d)(1) does not

apply to the situation presented by the case at bar. Tax-

payer’s argument is entirely unpersuasive.*”

[593]

It would make little sense to treat a § 963 distribution

by a different sourcing rule than that applicable to tradi-

tional dividends merely because § 963 establishes a schedule

of minimum amounts necessary to achieve the tax benefits

15 This is by no means to suggest that even without the recent

promulgation of Treas.Reg. § 1.902-3(d)(1) (1975), the tax-

payer’s position would prevail. Indeed, as we shall see, in light

of the consistency of the government’s rule on sourcing over the

years, the constancy of regulations that deem taxes paid by a

foreign subsidiary to have been paid in the country of its incor-

poration, and the facility with which the government’s sourcing

rule meshes with the legitimate role of the foreign tax credit,

the government’s sourcing rule appears to us far more consistent

with the intended interplay between subpart F and the foreign

tax credit provisions. Had the district court considered the

relative merit of the two rules, we think it would properly have

reached the same coriclusion.

16 For text of Treas.Reg. § 1.902-3(d) (1), see note 5, supra.

17There is an inconsistency between taxpayer’s arguing that

Treas.Reg. § 1.902-3(d)(1) is a legislative rule because it

amends regulations issued under § 963, which deals only with

minimum distributions, and its arguing that Treas.Reg. § 1.902-

3(d)(1) does not address the question of treating minimum dis-

tributions for tax credit limitation purposes. See note 6, supra.

B-13

promised by that section. The taxpayer has suggested no

basis in logic or policy for distinguishing dividends from

§ 963 distributions, and we have found none. Section 316(a)

defines “dividends” as corporate distributions made out of

earnings and profits. Section 962 by its term specifies that

“minimum distributions” are made out of the earnings and

profits of the controlled foreign corporation. Thus apart

from the minimum amounts specified in § 963 for minimum

distributions, § 963 distributions are identical to dividends;

they are in fact a class of dividends. Accordingly, we reject

taxpayer’s argument that Treas.Reg. § 1.902-3(d)(1) does

not address the question presented by the case at bar.

A far more difficult matter, and one that will occupy us

at some length, is whether § 1.902-3(d)(1) should be applied

retroactively to the taxable year in question. Two issues

arise through statute or regulation on the Secretary’s power

to prescribe retroactive regulations. Second, we must deter-

mine whether, under the peculiar circumstances of this

ease, the government’s attempt to apply the regulation ret-

roactively constitutes an improper exercise of the Secre-

tary’s power to promulgate retroactive regulations.

[3] We begin by noting that although Treas.Reg. §

1.902-3(d)(1) does not expressly state whether it is to have

retroactive effect, in the absence of limitations imposed by

statute or regulation such Treasury Regulations are gen-

erally entitled to retroactive application. Section 7805(b)

of the Code provides that the Secretary “may prescribe

the extent, if any, to which any ruling or regulation, relat-

ing to the internal revenue laws, shall be applied without

retroactive effect.” In undertaking to discern the intent of

Congress as to the retroactivity of such regulations as were

B-14

authorized under Section 7805(b) we are compelled to note

that the authorization to deal with the matter of retro-

activity is worded in a manner that indicates clearly that

in a generality of cases such rulings or regulations are to

be applied with retroactive effect. This results from the

fact that the authorization to the Secretary is to prescribe

the extent, if any, to which they shall be applied without

such effect. We discern from this a clear implication that

regulations adopted under the authority of that section will

generally have retroactive effect.

[4] The Commissioner’s failure to limit regulations to

prospective application is, to be sure, reviewable for abuse

of discretion. The point here is simply that the absence of

language specifically according Treas.Reg. § 1.902-3(d) (1)

retroactive effect is no bar to its application to this case.

See Dixon v. United States, 381 U.S. 68, 71-75, 85 S.Ct.

1301, 14 L.Ed.2d 223 (1965); Charbonnet v. United States,

455 F.2d. 1195, 1200 (5th Cir. 1972); Pollock v. Commis-

sioner of Internal Revenue, 392 F.2d 409 (5th Cir. 1968).

Anderson, Clayton claims to have discovered an applic-

able statutory limit to

[594]

this general power to issue retroactive regulations. It offers

the following attack on Treas.Reg. § 1.902-3(d) (1) : § 963(a)

requires a taxpayer to consent to all regulations promul-

gated under $963 “prior to the last day prescribed by

law for filing its return” for the taxable year; Treas.Reg.

§ 1.902-3(d)(1) is an indirect amendment to regulations

promulgated under § 963; the new regulation was adopted

after the last day for taxpzyer to file its 1964 return; con-

sequently taxpayer cannot be bound by a regulation to

which it did not consent. This argument presumes that tax-

B-15

payer’s consenting to certain regulations obligated the gov-

ernment to refrain from attempting to apply all other

regulations. That assumption is incorrect.

[5] Nothing in § 963 or any regulation adopted there-

under suggests that when taxpayer “consents” the govern-

ment is thereby entering an obligation that iimits its future

conduct. Rather, the taxpayer’s consent plainly represents

only his agreement not to challenge existing regulations.

There is clearly no requirement that a taxpayer consent to

the regulations in question as a condition of his being bound

thereby. With respect to regulations to which he has not

consented, the taxpayer stands in a position neither better

nor worse than that of any taxpayer confronted with an

applicable regulation. He is free to challenge the regula-

tion, but bound unless his challenge succeeds.

[6] Indeed, it would be unfair to prevent a taxpayer

from challenging regulations he has not seen. But if by his

consent to some regulations he does not consent to all that

may later be imposed, neither does he automatically shield

himself from all subsequently adopted regulations. We

conclude, therefore, that no statute or regulation limits the

Secretary’s power to adopt retroactive regulations regard-

ing the treatment of a minimum distribution for purposes

of computing the per-country limitation on foreign tax

credit.

Taxpayer’s second line of attack on Treas.Reg. § 1.902-3

(d)(1) is that retroactively applying that regulation to the

instant case would constitute an improper exercise of the

Secretary’s power to promulgate retroactive regulations.

Taxpayer relies on dicta from Chock Full O’Nuts Corp. v.

United States, 453 F.2d 300 (2d Cir. 1971). In that case,

the Commissioner adopted a regulation resolving the legal

B-16

issue involved in litigation pending between the taxpayer

and the government. The taxpayer argued that the regula-

tion should not be given retroactive effect because it repre-

sented an effort to change the policy of existing regulations

in order to support the government’s position in its pend-

ing litigation. The court said:

While retroactivity [of] tax regulations is . .. pre-

sumptively permissible, it is in each case for the court

to determine whether under all the circumstances ret-

roactive application would be warranted... . A tax-

payer, when acting in an area of unsettled law, has no

“vested interest in a hypothetical decision in his favor

prior to the advent of the regulations.” Helvering v.

Reynolds, 313 U.S. 428, 433, 61 S.Ct. 971, 974, 85 L.Ed.

1438 (1941). On the other hand, the Commissioner may

not take advantage of his power to promulgate retro-

active regulations during the course of a litigation for

the purpose of providing himself with a defense based

on the presumption of validity accorded to such regu-

lations.

[595]

453 F.2d 302-03 (footnotes omitted). The court termed

“questionable” the validity of the regulation at issue as an

exercise of the Commissioner’s power to promulgate retro-

active regulations, but found it unnecessary to resolve that

question.

[7] No case has held that the Secretary abused his dis-

cretion to promulgate retroactive regulations merely be-

cause the regulation at issue affected a legal matter pending

before a court at the time the regulation was adopted. To

be sure, the case at bar is distinctive in that the district

court had already issued its decision by the time the Secre-

tary adopted Treas.Reg. § 1.902-3(d)(1). We do not think

that fact crucial, however.’®

oer ee eeeeeeeeeeoeeeeeerrhlc melee —— ————

B-17

It is more important to consider how a regulation stands

in respect to prior law than to focus on how it relates in

time to the litigation in which the government seeks to

invoke it. The court in Chock Full O’Nuts, for example, was

addressing its quoted remarks to the taxpayer’s argument

that the Commissioner was trying to change settled law at

the eleventh hour in order to defend against taxpayer’s

claim. Viewed in that light, the Second Circuit’s concern is

well-taken.

Courts have declined to give retroactive effect to regula-

tions or rulings when retroactivity would work a change

18 Taxpayer calls our attention to the following language in Com-

missioner v. Goodwyn Crockery Co., 315 F.2d 110, 113, (6th Cir.

1963) :

Since the regulations were not in effect at the time the tax

liability accrued, or at the time of the [Tax Court] hearing,

they have no binding force here. They are authority, how-

ever, as a departmental ruling.

This statement of law is incorrect. If it were true that regula-

tions had no binding force merely because they were not in effect

when the tax liability at issue accrued, the Secretary would be

divested of his discretion to issue retroactive regulations. Not

only does the Sixth Circuit decision in Goodwyn Crockery fail

to consider § 7805(b) of the Code, it never once discusses the

concept of retroactive regulations. We can only conclude that

no one suggested to the Goodwyn Crockery court that the regu-

lations in question might have had retroactive effect. Other

courts have reached the same conclusion and have accordingly

disregarded the quoted language. For example, in Ezel Corp. v.

United States, 451 F.2d 80 (8th Cir. 1971), the court held that

the district court had erred by relying on the rule set forth in

Goodwyn Crockery to deny retroactive effect to a treasury

regulation. The Eighth Circuit noted that this erroneous view

of the law was contrary to § 7805(b) and Dizon v. United States,

381 U.S. 68, 74, 85 S.Ct. 1301, 14 L.Ed.2d 223 (1965).

Because the Goodwyn Crockery court was so obviously operat-

ing under a mistaken view of the law regarding retroactivity,

we can give no credit to its statement that regulations not

adopted by the time of the lower court’s hearing have no binding

force.

B-18

in settled law relied on by the taxpayer and implicitly ap-

proved by Congress, Helvering v. R. J. Reynolds Tobacco

Co., 306 U.S. 110, 116, 59 S.Ct. 423, 83 L.Ed. 536 (1939),

when it would lead to inequality of treatment between

competitor taxpayers, International Business Machines

Corp. v. United States, 343 F.2d 914, 170 Ct.Cl. 357 (1965),

cert. denied, 382 U.S. 1028, 86 S.Ct. 647, 15 L.Ed.2d 540

(1966), or when, in general, the result of retroactivity in a

particular case would be unduly harsh, see Woodward v.

United States, 322 F.Supp. 332, 335 (W.D.Va.) (dicta),

aff'd, 445 F.2d 1406 (4th Cir. 1971).

[8] From these cases we may distill a list of some of the

considerations that are relevant to a court in reviewing

the Secretary’s exercise of his discretionary power to adopt

retroactive regulations. That list includes: (1) whether or

to what extent the taxpayer justifiably relied on settled

prior law or policy and

[596]

whether or to what extent the putatively retroactive regu-

lation alters that law; (2) the extent, if any, to which the

prior law or policy has been implicitly approved by Con-

gress, as by legislative reenactment of the pertinent Code

provisions; (3) whether retroactivity would advance or

frustrate the interest in equality of treatment among simi-

larly situated taxpayers; and (4) whether according retro-

active effect would produce an inordinately harsh result.’®

Far from altering prior law or policy regarding the

sourcing of dividends received by a domestic corporation

from its foreign subsidiaries, Treas.Reg. § 1.902-3(d) (1)

19 The relationship in time between the promulgation of a regula-

tion and litigation in which the regulation would be controlling

if applied may be a component of this last factor. We reject the

taxpayer’s argument that the chronology should be dispositive,

B-19

expresses a position consistently held by the Treasury,

though not continuously manifested in the regulations.

Insofar as there was a vacuum in applicable regulations

after 1964 but prior to the promulgation of Treas.Reg.

§ 1.902-3(d) (1), the taxpayer could not, we think, justifiably

rely on a contrary sourcing rule.

Prior to the enactment of the 1954 Code, the Commis-

sioner provided in I.T. 4089, 1952-2 Cum.Bull. 142, that un-

less otherwise provided by law (as, for example, when the

income is United States source income under the pertinent

provisions of the statute now encompassed in §§ 861 and

862 of the 1954 Code) all dividends paid by a first tier

foreign subsidiary would be deemed to have been derived

from sources within the country in which the subsidiary

was incorporated, and that all taxes qualifying for the for-

eign tax credit would be treated as having been paid to the

country of the subsidiary’s incorporation.

ES RE Sree ee et en ne OE TD ee

nt i ta et Nr PLT A

In 1957 the Secretary incorporated the rule of I.T. 4089

in Treas.Reg. § 1.902-1(c), which provided that dividends

received from a foreign subsidiary “shall be deemed to

have been derived from sourcés within the foreign country

. in which such foreign corporation is incorporated, to

the extent that under section 862(a)(2) such dividends are

treated as income from sources without the United States

...” The new regulation also provided that all income taxes

paid or deemed paid by the foreign corporation to a for-

eign country would be deemed paid to the country of its

however. In addition, we note that the list of relevant considera-

tions is not intended to be exhaustive. For example, in a par-

ticular case it might become relevant to consider the extent to

which the new regulation responds to a policy inapplicable to

earlier years.

B-20

incorporation.2® Had Treas.Reg. §1.902-1(c) been con-

tinued in effect, it would have governed the sourcing issue

in the case at bar.

The enactment of the Revenue Act of 1962, Pub.L. 87-834,

76 Stat. 960, added subpart F to the Code and changed the

formula for computing the § 902 credit. The latter change

required certain revisions in the regulations promulgated

under § 902.21 Through Treas.Reg.

20 When in 1960 Congress added the overall limitation on the

foreign tax credit to the existing per country limitation, Act of

September 14, 1960, §1(a), Pub.L. 86-780, 74 Stat. 1010, the

Senate Report expressed approval of the source rule regarding

foreign taxes set forth in Treas.Reg. § 1.902-1(c). S.Rep.No.

1393, 86th Cong., 2d Sess., 4-5 reprinted in [1960] U.S. Code

Cong. & Admin.News, pp. 3773-74.

21 Section 9 of the Act changed the formula for computing the

§ 902 credit with respect to dividends received from other than

“less developed country” corporations. The change was a

response to a perception that an unjustified tax advantage re-

sulted when a domestic corporation received income in the form

of a dividend from a foreign corporation that paid tax at less

than the United States rate. The inequity resulted when the

amount paid in foreign taxes was not only allowed as a credit

in computing the United States tax of the corporation receiving

the dividend, but was also “in effect allowed as a deduction

(since the dividends can only be paid out of income remaining

after payment of the foreign tax).” S.Rep.No.1881, 87th Cong.,

2d Sess., reprinted in [1962] U.S. Code Cong. & Admin.News,

p. 3368. That is, as a result of including only dividend income

in the tax base of the domestic corporation (instead of dividend

income plus foreign taxes paid) and at the same time allowing a

foreign tax credit, the total of foreign and United States taxes

paid on earned income was less than would be paid by a domestic

corporation operating in this country (to the extent the United

States tax rate exceeded the foreign rate). Accordingly, the

Revenue Act of 1962 added a “grossing-up” provision, now

codified at § 902(d)(1) and §78 of the Code, by which a

domestic corporation electing to take a foreign tax credit must

include in its gross income an amount equal to the taxes of its

subsidiary that it is deemed to have paid for purposes of the

foreign tax credit provision with respect to the dividend income

received. Id, 3371-72, 3524. This matter is entirely independent

of the question in which foreign country foreign source income

should be sourced.

B-21

[597]

§ 1.902-5(a) (1965), the government declared that para-

graphs (a) through (e) of Treas.Reg. § 1.902-1 were inap-

plicable (with certain exceptions not relevant here) to

distributions received during taxable years beginning after

December 31, 1962. Among the provisions withdrawn was

Treas.Reg. § 1.902-1(¢) (1957).

Nothing in the new Act changes or appears to have re-

quired a change in the general source rule of dividends

from foreign corporations embodied in Treas.Reg. § 902-1

(c). Accordingly, the Commissioner proposed to continue

this source rule in a new regulation, § 1.902-3(d)(1), Pro-

posed Treasury Regulations on Income Tax (1954 Code),

29 Fed.Reg. 12838 (1964). When the amended Treasury

Regulations incorporating the changes made by the

Revenue Act of 1962 were adopted, however, it was an-

nounced that proposed Treas.Reg. § 1.902-3(d)(1) and cer-

| tain other proposed regulations would be “reissued with a

; new notice of proposed rulemaking.” T.D. 6805, 1965-1 Cum.

| Bull. 39.22 No dividend sourcing rule was in fact adopted

| until 1975.”

SS Ea —

22 The regulations incorporating the changes made by the 1962

Act were designated as Treas.Reg. §§ 1.902-3 and 1.902-4 (1965).

23 The government asserts that the failure to approve Treas.Reg.

§ 1.902-3(d)(1) before 1975 arose from the problem of de-

termining the amount of actual dividends and § 78 dividends

(under § 73, a domestic corporation that elects to take foreign

tax credits must treat as a dividend an amount equal to the

foreign taxes that the domestic corporation is deemed to have

paid under § 902(a) or § 960(a)(1)) to be treated as foreign

source income for purposes of the tax credit when a portion of

the actual dividends must be treated as United States source

income under § 861. This problem does not arise in the case at

bar because the entire dividend taxpayer received from Lau-

sanne concededly constituted foreign source income.

A Sr ai OE A Pm

iii ell

B-22

Nevertheless, in the interregnum during which no treas-

ury regulation governed the sourcing issue involved in the

case at bar, neither by regulation nor ruling did the Com-

missioner intimate his intention to follow a foreign divi-

dend sourcing rule other than that which had obtained

prior to the Revenue Act of 1962. Moreover, the Commis-

sioner did adopt significant analogues to this dividend

sourcing rule in related areas.

For example, new Treas.Reg. § 1.902-3(d)(2) (1965) pro-

vided that foreign taxes paid by a first tier subsidiary are

deenied to have been paid to the country of its incorpora-

tion. Treas.Reg. § 1.960-

[598]

1(i) (1971), which deals with the computation of foreign

tax credit when the foreign subsidiary’s income is taxed

to the domestic parent under subpart F of the Code, pro-

vides that such income “shall be deemed to be derived from

services within the foreign country or possession of the

United States under the laws of which such first-tier corp-

oration ... is created or organized.” That is, if the subpart

F income of Lausanne had been imputed to taxpayer under

§ 951 of the Code, rather than actually distributed pursuant

to § 963, the sourcing rule in Treas.Reg. § 1.960-1(i) would

have controlled.

Given the skein of regulation into which the Commis-

sioner has woven the sourcing rule originally expressed

in I.T. 4089, it should have come as little surprise to the

taxpayer to find the same sourcing rule approved in

Treas.Reg. § 1.902-3(d)(1) (1975).

24 Indeed, had the Secretary never promulgated Treas.Reg.

§ 1.902-3(d)(1) (1975) we should find the consistency with

which the “country of incorporation” sourcing rule has been

applied in related areas a powerful argument for applying it

Le 8 ee

B-23

{9} In sum, Treas.Reg. § 1.902-3(d)(1) (1975) did not

alter a settled prior law or policy.”® Insofar as there was

any uncertainty regarding the proper dividend sourcing

rule during the interregnum between 1962 and 1975, we do

not think taxpayer could justifiably have relied on a soure-

ing rule contrary to that which concededly obtained before

and after this period. The best that taxpayer can claim is

that the law or policy was unsettled during this period.*®

Under the circumstances, that is not enough to pre-

to the problem at hand. In short, the government’s sourcing rule

seems to us more consistent with administrative policy than the

taxpayer’s proposed dividend sourcing rule.

25 That a regulation or ruling does alter settled prior law or policy

upon which a taxpayer has relied does not, of course, necessarily

preclude its retroactive effect. For example, in Pollack v. Com-

missioner of Internal Revenue, 392 F.2d 409 (5th Cir. 1968),

this court held that even assuming a regulation was inconsistent

with a policy announced in a prior Technical Information Re-

lease, the regulation could still be given retroactive effect at least

if the prior interpretation of law was erroneous:

The Commissioner may indeed retroactively correct any prior

erroneous interpretation of the law, even though a taxpayer

may have relied to his detriment on the Commissioner’s

mistake.

392 F.2d at 411. See also Dixon v. United States, 381 U.S. 68,

79-80, 85 S.Ct. 1361, 1308, 14 L.Ed.2d 223, 231 (1965) (“Insofar

as petitioners’ arguments question the policy of empowering the

Commissioner to correct mistakes of law retroactively when a

taxpayer acts to his detriment in reliance upon the Commis-

sioner’s acquiescence in an erroneous Tax Court decision, their

arguments are more appropriately addressed to Congress.’’)

(footnotes omitted).

26 Taxpayer asserts that in the absence of existing segulations

under § 902, it was required to look to Treas.Reg. § 1.901-2(d)

(1957), which referred it to § 861 and succeeding sections of the

Code for determining the sources of income received. Sections

861(a)(2) and 862(a)(2) pertain to the question whether in-

come received was United States source income or foreign source

income. Taxpayer argues that Treas.Reg. §§ 1.861-1 to 1.863-5,

which govern the extent to which income is deemed from sources

within or without the United States, are predicated not on a

country of incorporation test but instead look to the place where

the income was earned. Taxpayer concedes, however, that

B-24

[599]

clude our according Treas.Reg. § 1.902-3(d)(1) retroactive

application.’

Taxpayer’s final objection to according retroactive effect

to Treas.Reg. § 1.902-3(d)(1) is that as an amendment to

regulations issued under § 963 the regulation in’ question

must be viewed as issued pursuant to the specific delegation

of power contained in § 963(f). This, taxpayer argues,

means that Treas.Reg. § 1.902-3(d)(1) is legislative as

opposed to merely interpretative in nature. Taxpayer

argues that we should not accord retroactive effect to a

rule legislative in nature when to do so would produce a

harsh or unfair result.

[10] That legislative rules may be retroactive is settled

law. See, e. g., Manhattan Equipment Co. v. Commissioner

of Internal Revenue, 297 U.S. 129, 135, 56 S.Ct. 397, 400,

80 L.Ed. 528, 531-32 (1936); Charbonnet v. United States,

455 F.2d 1195, 1200 (5th Cir. 1972).2° Taxpayer does not

§§ 861 through 864 of the Code are devoid of specific provisions

regarding the determination from which foreign country income

has been derived once that income is determined to be foreign

source income. Nothing in these sections of the Code or in any

regulation promulgated thereunder suggests these provisions

were intended to provide a general principle to be applied in

locating a specific foreign country as the source of dividend

income.

27 The additional considerations we have identified as relevant to

whether the Commissioner abused his discretion by adopting a

retroactive regulation do not militate against retroactive appli-

eation of Treas.Reg. § 1.902-3(d)(1). According retroactive

effect to the regulation would serve the interest of treating

equally similarly situated taxpayers and would not have an

unduly harsh result in this case. Finally, we find no evidence

that Congress had implicitly approved a prior contrary rule.

28 See K. Davis, Administrative Law Text § 505, 133 (3d ed.

1972) :

Statutes may be retroactive without violating due process;

Aina lO Ti Tima i NO a LN

B-25

claim that retroactive operation of Treas.Reg. § 1.902-3(d)

(1) would violate due process. We have already considered

and rejected the argument that retroactive application of

the regulation would be inconsistent with “consent” lan-

guage of § 963. Nothing in § 902 would preclude retroactive

application of a retroactive regulation promulgated there-

under. Since retroactive application of the regulation is

consistent with the Secretary’s statutory authority to pre-

scribe regulations, and since it effects no change in settled

law, even if Treas.Reg. § 1.902-3(d) (1) is deemed legislative

in character there is no bar to its application to the instant

case.

Neither the courts nor Congress have drawn any distine-

tions between interpretative and legislative Treasury Regu-

lations as regards their retroactivity. See Rogovin, The

Four R’s: Regulations, Rulings, Reliance, and Retroactiv-

ity— A View From Within, [1976] Stand.Fed.TaxRep.

(OCH) { 5980A.0153, 5980A.016."° Treas.Reg. § 1.902-3

(d) (1) is the first

the test is whether they are unreasonably retroactive. The

same test applies to legislative rules, except that courts are

less reluctant to upset administrative rules than to upset

statutes, and except that rules must be within can power

as well as constitutional .

(footnote omitted).

29 A distinction similar to that between legislative and interpreta-

tive rules may become significant with regard to retroactivity

when a new regulation alters an existing regulation promulgated

under a statute that Congress has reenacted. The party seeking

to escape retroactive application of the new regulation will

argue that Helvering v. R. J. Reynolds Tobacco Co., supra, 306

U.S. 110, 59 S.Ct. 423, 83 L.Ed. 536, precludes such retroactive

effect. It has been held, however, that the Reynolds Tobacco

principle (that by repeated reenactment of a statute Congress

gives its sanction to existing regulations) is applicable only

when the regulations are legislative as opposed to “administra-

tive” in character. Automobile Club of Michigan v. Commis-

sioner of Internal Revenue, 20 T.C. 1033, 1041 (1953), aff'd, 230

F.2d 585, 589 (6th Cir. 1956), af’d, 353 U.S. 180, 185-86,

77 S.Ct. 707, 1 L.Ed.2d 746, 751 (1957). See also Helvering v.

Reynolds, 313 U.S. 428, 61 S.Ct. 971, 85 L.Ed. 1438 (1941),

B-26

[600]

regulation to provide a sourcing rule for § 902 as revised by

the Revenue Act of 1962. It is, as we have seen, consistent

with the only prior dividend sourcing rule that obtained

prior to the 1962 Act. Under these circumstances at least,

that a revulation is legislative in character does not affect

the ques on whether it should be applied retroactively.”

which | nfined Reynolds Tobacco to its facts, specifically the

existence of a prior Regulation that negatived a tax liability

that the new and putatively retroactive regulation prescribed,

and announced that Congressional reenactment of a statute that

had been given a settled construction was no more than an aid in

statutory interpretation and, where no regulations embodied the

prior construction, did not preclude retroactively applying a

regulation contrary to that construction.

80 Strictly speaking, the question of retroactivity can arise only

with respect to rules that are at least in part legislative in

character. That is to say, to the extent a regulation merely

interprets a statute, it in theory merely elucidates a meaning

that has resided in the statute since its enactment. If an in-

terpretative regulation merely clarifies what the language of

the statute was intended to convey, it is ultimately misleading

to term it retroactive. “It is no more retroactive in its operation

than is a judicial determination construing and applying a

statute to a case in hand.” Manhattan General Equipment Co. v.

Commissioner of Internal Revenue, 297 U.S. 129, 135, 56 S.Ct.

397, 400, 80 L.Ed. 528, 532 (1936).

On the other hand, it seems unrealistic to suppose that many

interpretative regulations merely express the one correct and

intended interpretation of the statute under which they were

promulgated. Many interpretative regulations will make explicit

the answers to questions that Congress did not anticipate. Others

will offer an answer that never crystallized during che legisla-

tive process. Professor Davis writes:

[A] significant portion of what is called “interpretation” is

not interpretation at all but is in truth creative law making.

Whenever interpretative rules do in fact make new law,

retroactive law making should be dealt with as such, un-

prejudiced by the false notion that results never flow from

the interpreter. Problems of retroactivity then will be solved

on the basis of ideas of fairness and the necessities of practical

administration.

Retroactive clarification of uncertain law ordinarily in-

volves no unfairness. It is retroactive change of settled law,

B-27

IV.

Having demonstrated that Treas.Reg. § 1.902-3(d) (1)

| may be applied retroactively to the taxable year in ques-

| tion, we

[601]

must consider next whether that regulation is valid. The

| taxpayer does not question the procedure by which the

regulation was adopted, but only its substantive validity.

Accordingly, taxpayer bears a heavy burden. The regulation

“must be sustained unless unreasonable and plainly incon-

sistent with the revenue statutes.” Bingler v. Johnson, 394

not retroactive settling of unsettled law, which may produce

unjust results.

K. Davis, Administrative Law Text, § 5.05, 1385 (8d ed. 1972).

By the same token, however, even legislative regulations must

be consistent with the statute under which they were promul-

gated. We term them “legislative” because they are made pur-

suant to a specific delegation of authority and often without the

particular legislative guidance typically found in statutes that

spawn only interpretative regulations. But in a real sense they

{ still interpret or explain existing legislation.

The ideal types of legislative and interpretative regulations

thus quickly break down in practice. Although the distinction

has considerable utility for some purposes, that one regulation

is denominated legislative in character and another interpreta-

tive in character contributes little to an understanding of

whether each ought to be applied retroactively.

In any event, whatever sharpness the distinction between

legislative and interpretative rules might otherwise have is

dulled by § 7805(a) of the Code, which authorizes the Secretary

generally to prescribe all rules that enforcement of the Code

requires. See Continental Equities Inc. v. Commissioner of

Internal Revenue, 551 F.2d 74, 82 (5th Cir. 1977) (containing

language that would eliminate the distinction entirely in tax

eases by characterizing as legislative all regulations issued pur-

suant to § 7805(a).)

For purposes of determining retroactivity, at least, the em-

phasis should be not whether a regulation more closely resembles

the legislative or interpretative ideal type, but how the new

regulation stands in relation to prior law or policy.

r w

B-28

U.S. 741, 749-51, 89 S.Ct. 1439, 1444, 22 L.Hid.2d 695 (1969),

quoting Commissioner of Internal Revenue v. South Texas

Lumber Co, 333 U.S. 496, 501, 68 S.Ct. 695, 698, 92 L.Ed.

831 (1948); Fitegerald Motor Co. v. Commissioner of In-

ternal Revenue, 508 F.2d 1096 (5th Cir. 1975). Anderson,

Clayton has not met this rigorous standard.

Taxpayer argues that the country of incorporation rule

contained in Treas.Reg. § 1.902-3(d) (1) is inconsistent with

the basic concept of the foreign base company component

of subpart F income. See note 1, supra. By definition, for-

eign base company income must be earned in a country

other than that in which the controlled foreign corporation

is incorporated. Treas.Reg. § 1.902-3(d)(1) required tax-

payer to source a minimum distribution of Lausanne’s sub-

part F income to the country of the subsidiary’s incorp-

oration for purposes of determining the limitation on

taxpayer’s foreign tax credit. Anderson, Clayton contends

that it is inconsistent to source to the country of Lausanne’s

incorporation a distribution of income that by definition

must be earned outside that country.

We find no such inconsistency between Treas.Reg. § 1.902-

3(d)(1) and the provisions of subpart F. The purpose of

those provisions was to eliminate tax havens “such as the

Swiss corporation which often serves as merely an address

for sales made in every country in Europe except Switzer-

land,” to prevent a corporation from “flout[ing] our tax

laws by simply setting up an address company, say in

Panama, to sell goods in Europe which did not originate in

Panama... and which had nothing to do with Panama.”

108 Cong.Rec. 17750, 17752 (1962) (remarks of Sen. Kerr,

floor manager of H.R. 10650). That is why subpart F is

concerned with, for example, income earned by a Swiss

subsidiary outside Switzerland. With respect to any income

earned within Switzerland, or more generally, the country

B-29

in which the subsidiary is incorporated, the foreign corpora-

tion is not acting as the sort of tax haven or “address

company” against which Congress aimed subpart F. Con-

gress’s reasoning on this point can hardly be said, how-

ever, to carry decisive implications for the separate ques-

tion regarding how a distribution of subpart F income is

to be sourced for purposes of the foreign tax credit. Insofar

as there are such implications they are entirely consistent

with Treas.Reg. § 1.902-3(d) (1).

We start with the rule embodied in Treas.Reg. § 1.902-3

(d) (2) (1965) that deems taxes paid by a foreign subsidiary

to have been paid to the country of the subsidiary’s in-

corporation. This regulation carried forward the rule of

LT. 4089 (1952-2 Cum.Bull. 142) anu i'reas.Reg. § 1.902-

1(c) (1957). In 1960, Congress expressed its approval of

the rule. See note 20 supra. As we have seen, nothing in

the Revenue Act of 1962 was related to this rule (even

assuming for the sake of argument that the 1962 Act might

have left open the proper dividend sourcing rule), and

the Commissioner promptly adopted it once again. Given

legislative reenactment of § 902 and the contemporaneous

construction afforded that section in Treas.Reg. § 1.902-

3(d) (2), the

[602]

rule deeming taxes paid by a foreign subsidiary to have

been paid to the country of its incorporation has force of

law. Taxpayer does not contest the validity of this regu-

lation.

Congress included in subpart F' § 963, which was intended

to offer the corporate taxpayer some relief from the effects

of § 951. But, as we have seen, the amount of the required

minimum distribution varies inversely with the foreign tax

B-30

rate. This was thought necessary in order to ensure that

the combined United States and foreign tax rates on the

subsidiary’s income would not be substantially below the

United States corporate rate. S.Rep.No.1881, 87th Cong.,

2d Sess. 88, 1962 U.S.Code Cong. & Admin.News, p. 3391.

In short, the country to which the foreign subsidiary pays

taxes is integral to the concept of a § 963 minimum dis-

tribution.*?

The taxpayer’s sourcing rule, which it claims is the only

rule consistent with subpart F, would allow the taxpayer

to minimize the tax equalizing effects of the minimum dis-

tribution by using the distribution to claim increased tax

credits for the relatively higher taxes that taxpayer’s South

American subsidiaries paid to Argentina, Brazil and Peru

and, thus, to reduce its overall tax burden. This would be

true even though the earnings underlying the distribution

(the taxes on which Lausanne paid only to Switzerland)

had absolutely nothing to do with the actual taxes paid to

Argentina, Brazil and Peru by the South American sub-

sidiaries. In other words, application of taxpayer’s sourcing

rule would sever the foreign country to which a foreign

subsidiary paid creditable taxes on its earnings from any

necessary connection to the foreign country to which the

domestic parent attributes a distribution of those earnings

for purposes of the foreign tax credit.

We need not consider whether, in light of the legislative

history of subpart F, the Code would permit such a curious

result. It suffices for our purposes that the Code does not

require that result. Nothing in subpart F forbids the Seere-

81 When the foreign tax rate in the subsidiary’s country of incor-

poration is high, for example, it is unlikely that the subsidiary

is operating from a tax haven country, and the amount of the

distribution (and hence the percentage of United States tax

that the domestic parent must pay presently) is correspondingly

smaller.

| B-31

tary to correlate the foreign country to which a foreign sub-

sidiary is deemed to pay taxes on its earnings and profits

with the source of a minimum distribution of those earnings

and profits for purposes of the foreign tax credit.**

32 In many, perhaps most situations, the sourcing rule embodied in

Treas.Reg. § 1.902-3(d)(1) better effectuates the purpose of the

§ 902 tax credit to avoid double taxation. Suppose, for example,

that the sourcing rule advocated by Anderson, Clayton were

applied to determine the per country limitation on the foreign

tax credits allowable to domestic Corporation X. Corporation X

owns the voting stock of Corporation Y, which is incorporated

in country Alpha. Y derives its income from sales of goods in

Beta and Gamma. Y pays an income tax to Beta and Gamma

with respect to income earned in each country and an income

tax on all of its income to Alpha. Y distributes a § 963 dividend

from its foreign base company sales income. X, which has re-

ceived dividends from subsidiaries in Delta and Epsilon, elects

the per country limitation.

All Y’s income taxes will be deemed to have been paid to

Alpha, as required by Treas.Reg. §1.902-3(d) (2). If Treas.Reg.

§ 1.902-3(d)(1) governs, the dividend received by X from Y

will be sourced in Alpha. Since for purposes of computing X’s

foreign tax credit, its subsidiary Y’s taxes are deemed to have

been paid to Alpha, and since for purposes of computing the

i limitation of X’s foreign tax credit, the dividend is deemed to

be sourced in Alpha, X will receive the maximum foreign tax

credit. ;

On the other hand, if Anderson, Clayton’s sourcing rule

governs, a very different result will obtain. X will be deemed to

have no foreign source income from Alpha, but only from Beta

and Gamma, where Y earned the income. But X (through its

subsidiary, Y) would be deemed to have paid foreign taxes only

to Alpha, not to Beta and Gamma. Hence, X would be entitled

to no foreign tax credit at all.

In its brief, the taxpayer demonstrates that the sourcing rule

embodied in Treas.Reg. § 1.902-3(d) (1) will be subject to abuse.

The hypotheticals taxpayer constructs correctly point out some

dangers involved in sourcing dividends in the subsidiary’s coun-

try of incorporation and call for attention by the Commissioner.

Nevertheless, we think that the disadvantages of the country of

incorporation rule are counterbalanced by its advantages, as

evidence by the hypothetical above. In any event, the proper

dividend sourcing rule represents a policy choice that Congress

has delegated to the Secretary, not the courts, and we decline to

upset his considered choice.

B-32

[603]

We conclude that Treas.Reg. § 1.902-3(d) (1) is not “plain-

ly inconsistent” with the Code and that, accordingly, the

taxpayer’s challenge to the validity of the regulation can-

not be sustained. Having found the regulation both valid

and retroactively applicable to the case at bar, we must

reverse the district court’s judgment on this issue.

THE DEDUCTIBILITY OF AN UNREALIZED

FOREIGN EXCHANGE LOSS

The taxpayer has taken a cross-appeal from the district

court’s determination that Anderson, Clayton is not en-

titled to a loss deduction with respect to the decline in for-

eign exchange value of promissory notes it received as

dividends from its Argentine subsidiaries during fiscal year

1964. We uphold the district court’s conclusion. Consequent-

ly we need not reach the issue of the source of such a loss

for purposes of the § 904(a)(1) limitation on foreign tax

credit.

¥.

In fiscal 1964, the Argentine government issued an order

“blocking” the country’s currency. That is, Argentine pesos

could be neither expatriated from Argentina nor converted

within that country into freely convertible currency of any

other country. Subsequently, on December 20, 1963 and

January 9, 1964, Anderson, Clayton received dividend dis-

tributions from its Argentine subsidiaries in the form of

negotiable promissory notes payable to taxpayer in Argen-

tine pesos.

The taxpayer determined the value of the notes by con-

verting their principal amount into United States dollars

at the rate of exchange prevailing on the date of distribu-

tion. It included that amount, $1,150,320.87, in its gross in-

come as a dividend.

APD eed ee

B-33

By the end of fiscal 1964, the value of Argentine pesos

had declined relative to dollars. Taxpayer determined the

United States dollar value of the promissory notes as of

the end of fiscal 1964 and deducted $278,892.29 as an ordi-

nary business loss. Taxpayer reported this loss as derived

from sources within the United States. It premised this

sourcing of the loss on the fact that it held the promissory

notes within the United States at all times during fiscal

1964 subsequent to their receipt. At no time in fiscal 1964

did Anderson, Clayton actually exchange the notes for

dollars.

Upon an audit of taxpayer’s return for the taxable year

in question, the Internal Revenue Service challenged the

taxpayer’s sourcing that loss in the United States. At trial

the government also argued that the taxpayer realized no

loss from the decline in value of its notes.

[604]

The district court agreed with the latter proposition and

thus had no occasion to reach the sourcing issue. Moreover,

the district court determined that the government was

neither collaterally estopped to deny taxpayer a loss de-

duction by virtue of a prior Court of Claims decision,

Anderson, Clayton & Co. v. United States, 168 F.Supp. 542,

144 Ct.Cl. 106 (1958), nor foreclosed from objecting to the

deduction by an agreement executed in 1942 by taxpayer

and the Commissioner relating to taxpayer’s foreign branch

accounting.®®

38 With respect to the prior settlement agreement, the district

court held that it was intended only to adjust operating income

between the taxpayer parent and its foreign holdings, not to

authorize deductions for foreign exchange losses in the value of

dividends issued by a foreign subsidiary to its parent. Regard-

ing the prior judicial decision, the court held that the Court of

Claims “was attempting to rectify an unfortunate result of war

and was not intending to set a precedent for future litigation.”

B-34

VI.

[11, 12] It should be clear at the outset that allowing

Anderson, Clayton an ordinary business loss deduction for

the decline in foreign exchange value of its promissory

notes would violate a fundamental tenet of our income tax

system. That is the proposition that property must be sold,

abandoned, injured by physical causes or demonstrated to

be worthless before a taxpayer is entitled to a deductible

loss. See, e. g., United States v. S.S. White Dental Mfg. Co.,

274 U.S. 398, 401, 47 S.Ct. 598, 71 L.Ed. 1120 (1927). It

is equally clear that mere diminution in the value of foreign

money is not enough to permit a deduction for a loss sus-

tained. Losses may be recognized only when the taxpayer

converts foreign currency into dollars. 8. J. Mertens, Law

of Federal Income Tacation § 28.82 (rev. ed. 1975).

The taxpayer does not deny that allowing it a deduction

for the mere decline in value of the promissory notes would

violate this basic rule of taxation. Anderson, Clayton never-

theless boldly insists that we are compelled to reach that

result by a Court of Claims decision handed down almost

twenty years ago, Anderson, Clayton & Co. v. United States,

168 F.Supp. 542, 144 Ct.Cl. 106 (1958), and an agreement

struck thirty-five years ago between taxpayer and the Com-

missioner regarding taxpayer’s foreign branch accounting

and, allegedly, taxpayer’s foreign subsidiary accounting.

[13] For fiscal years 1933 and 1934 the taxpayer used

a method of accounting whereby it determined the profits

of its foreign branches by adjusting the current accounts

on their books to dollar values at the close of each fiscal

year. Anderson, Clayton carried this amount in terms of

dollars to the home office account and reported it as income

for United States tax purposes. The IRS challenged tax-

—————————————————eeeeeeeeeeeereeereererl

‘at arene wt

B-35

payer’s method of accounting for 1933 and 1934. Taxpayer

filed suit in tax court. Prior to that court’s adjudication

on the merits, the parties reached a settlement agreement.

That agreement, reached in 1942, provided that taxpayer

was to compute its income by applying consistently the

accounting practice it had adopted:

The income of the Havre Branch and other autonomous

foreign offices keeping their accounts in a foreign cur-

rency is to be determined by the difference in dollar

net worth at the beginning and end of the year adjusted

for any profits transferred from such branch during

the year.

[605]

The first skirmish between the taxpayer and the govern-

ment concerns the scope of this agreement. The taxpayer

asserts that the agreement required it to recognize gains or

losses from exchange fluctuations on payables to and receiv-

ables from its foreign branches and its foreign subsidiaries.

The government argues that the agreement was limited

to taxpayer’s foreign branch accounting practices.

Taking merely the language of the agreement, the gov-

ernment’s view seems correct. Taxpayer argues that the

“other autonomous foreign offices” language encompasses

foreign subsidiaries. Since the phrase is preceded by the

word “other”, which assumes that the Havre branch was

an “autonomous” office, we do not think the phrase carries

the freight taxpayer would load upon it. The phrase is

entirely consistent with the notion that “branches” are au-

tonomous and that the agreement included not only Le

Havre but also other branches.

Moreover, the phrase, “Havre and other autonomous for-

eign offices” is followed after an interval by the words “such

B-36

branch,” which obviously refer back to the former quoted

phrase. It seems likely, therefore, that the agreement en-

visaged taxpayer’s applying its accounting method only to

foreign branches. This inference is strongly reinforced upon

considering the overall nature of the agreement.

The agreement represents the resolution of a dispute

concerning the taxpayer’s income. It begins by addressing

the question of properly calculating the income of the Havre

Branch and other offices that kept their accounts in foreign

currency. Taxpayer would be concerned with computing

the income of a foreign entity only to the extent that its

income was reflected in taxpayer’s income for purposes

of United States tax. At the time this agreement was written

— before the advent of subpart F — only the income of its

unincorporated branches was income taxable to Anderson,

Clayton. Adjustments in the income of its branches con-

stituted adjustments in taxpayer’s income. This was not

true of subsidiaries. The income of a subsidiary mattered

directly only insofar as taxpayer received from it a divi-

dend. Hence, the most sensible construction of the 1942

agreement is that it addressed the question how taxpayer

was to reflect the foreign currency income of foreign

branches in its own income. Nothing in the agreement ad-

dresses the treatment for tax purposes of dividends received

by the parent from a foreign subsidiary.

That the 1942 agreement concerned only foreign branch

accounting is enough to warrant our resolving this part of

the dispute in the government’s favor. We note additionally,

however, that Anderson, Clayton conceded at oral argument

that even if the 1942 agreement did address the problem of

dividend income, it could bind the government only with

respect to the taxable years covered by that agreement.

a EO OA ee

B-37

Taxpayer presents a more serious claim with respect to

the collateral estoppel effect of Anderson, Clayton & Co.

v. United States, 168 F.Supp. 542, 144 Ct.Cl. 106 (1958).

That case followed the government’s challenge to a claimed

exchange loss determined under the same accounting prac-

tice countenanced by the 1942 settlement agreement. The

court interpreted the settlement agreement in language that,

taxpayer claims, compels us to accept taxpayer’s construc-

tion.

[606]

Moreover, taxpayer asserts, the judgment in Anderson,

Clayton, supra, awarded taxpayer a deduction for the di-

minution in foreign exchange value of a receivable from a

foreign subsidiary.

Taxpayer thus attempts to bootstrap its way to a re-

versal. The argument is as follows: Although the settlement

agreement alone could not bind the Commissioner for future

tax years, and although it may be arguable whether the

1942 agreement even covered foreign subsidiaries, none-

theless the Court of Claims decision which interpreted the

agreement to be binding and to cover foreign subsidiaries

must control this case.

We think both the 1942 agreement and the Court of

Claims’ holding far more limited than taxpayer’s reading

would suggest.

In 1930 Anderson, Clayton established a branch office

in Alexandria, Egypt. In 1939, shortly after the outbreak

of the Second World War, the Egyptian government blocked

the conversion of Egyptian pounds into United States dol-

lars. Taxpayer could thus no longer remit the profits of

its Egyptian branch to its home office.

B-38

The branch office’s books included the account of Nile

Ginning Company, a foreign subsidiary of Anderson, Clay-

ton. The current Egyptian pound account of Nile Ginning

on the books of the branch and also apparently, of the

parent company was treated in the same manner as all other

foreign currency balances. That is, it was valued in dollars

at the current rate of exchange and at the end of each

fiscal year the difference between that value and the value

previously recorded on the books was carried into an “op-

tional account” as a gain or loss in exchange. Taxpayer ad-

justed its accounts twice a year and reflected in its tax

returns at the end of each fiscal year the resulting “profit”

and “loss.”

As of July 1945 taxpayer had net unremitted earnings

of 128,119.71 Egyptian pounds that had been reported as

United States income at the rate of $4.13 per pound. From

1945 until 1949, the taxpayer continued to take into its

United States income for tax purposes the United States

dollar value of its branch office profits. In 1949 taxpayer

liquidated its branch office and the Nile Ginnine Company

took over the branch’s assets and liabilities. In July 1949

taxpayer had on its books a current account receivable of

250,665.745 Egyptian pounds, representing blocked funds

at the rate of $4.13 per pound.

In September 1949 Britain devalued the pound sterling.

The Egyptian pound plummeted. By July 1950, the Egyptian

pound was worth $2.50. The resulting decrease in taxpayer’s

blocked Egyptian earnings amounted to $413,463.19, for

which taxpayer claimed a loss deduction on its fiseal 1950

income tax return.

For tax years 1946-1949, taxpayer had elected to file

deferred income tax returns under Mimeograph 6475, 1950-1

Cum.Bull. 50, which specified particular tax consequences

when foreign currency income was “blocked” by the foreign

tees ee a

B-39

country. Under this Mimeograph, the taxpayer would not

report such income until the foreign country lifted its cur-

rency restrictions. The Mimeograph provided specifically

that a taxpayer that elected to defer reporting its blocked

income waived the right to claim that the deferrable income

was includible in its gross income for any year other than

the year restrictions were lifted.

Taxpayer claimed that notwithstanding its election to file

deferred income tax returns for the years 1946-1949, the

1942 settlement agreement allowed it to

[607]

ignore the provisions of the Mimeograph and include the

1946-1949 exchange fluctuations of its Egyptain account in

determining its 1950 taxable income. That was the only

question the Court of Claims decided in 1958. The court

ruled that taxpayer could not take a deduction for foreign

exchange losses for the taxable years 1946-1949. It reasoned

that because the claimed 1946-1949 loss was based upon

amounts unreported as income, taxpayer could not take a

deduction. That is the holding of the case.

In the case at bar, Anderson, Clayton relies not upon

this holding but upon an additional part of the court’s

judgment.

In its 1950 tax return, taxpayer had also claimed loss

deductions for exchange fluctuations in its pre-1946 blocked

Egyptian income. The parties did not litigate the propriety

of these deductions. The government conceded the point.

The court wrote:

After filing of suit in this court the Government has

conceded that with respect to 47,487.426 Egyptian

pounds in the Egyptian account plaintiff is entitled to

a loss deduction of $77,404.50 in 1950. The 47,487.426

B-40

Egyptian pounds represent earnings for years prior

to 1946 which were included in United States income

at the exchange rate of $4.13 per pound and upon which

United States taxes have been paid.

Anderson, Clayton & Co. v. United States, supra, 168 F.

Supp. at 545. The court stated expressly that this portion

of the Egyptian account represented the Egyptian account

of the Alexandria branch. Jd. at 545 n. 2. No mention is

made of the earnings of the subsidiary, Nile Ginning.

Consequently, the district court’s characterization of

Anderson, Clayton, supra, as holding “that plaintiff was

entitled to a loss deduction for exchange losses determined

under its accounting practice with respect to all payables

from foreign branches, subsidiaries, or unrelated entities

for which the plaintiff had a tax basis” is unnecessarily

overbroad. First, the judgment of the Court of Claims al-

lowed Anderson, Clayton a loss deduction with respect to

unremitted earnings of a branch, not a subsidiary. Indeed,

in light of that court’s finding of fact that the 1942 agree-

ment was one “concerning ... foreign branch accounting,”

it would have been surprising had that court sanctioned the

extension of the agreement to cover foreign subsidiaries.

See Record at 23.54 Second, even that portion of the judg-

ment was based not on a fully litigated matter, but a con-

cession of the government. As we have seen, the Court of

Claims held only that taxpayer was not entitled to a loss

84 Against the Court of Claims’ flat statement that the settlement

agreement concerned foreign branch accounting, taxpayer

juxtaposes the court’s observation that “pursuant to [that]

agreement, plaintiff thereafter consistently reflected gains and

losses from its exchange fluctuations on accounts payable to or

receivable from its foreign subsidiaries and unrelated concerns

as well as from its foreign branches.” 168 F.Supp. at 543. This

empirical account of taxpayer’s practices can hardly be taken as

decisive on the question of its entitlements.

cai rer tantly: tone tieme Sonia Daim Raa

B-41

deduction arising from exchange fluctuations for the years

1946-1949,

Assuming for the sake of argument that a judgment

based on the government’s concession could have collateral

estoppel effect, that judgment is inapposite to the case at

bar. The Havre branch of the 1942 settlement agreement

and the Alexandria branch of the Court of Claims decision

were not separate corporate entities, and the income earned

[608]

by taxpayer through those offices was its own. Although

the Alexandria branch was no longer in existence during

taxpayer’s 1950 fiscal year, the government could reason-

ably have conceded that the intent of the agreement would

serve to allow taxpayer to deduct the decline in dollar value

of the Nile Ginning current account to the extent that it

represented the Alexandria branch’s unremitted earnings

upon which taxpayer had paid United States income tax.

The government could have conceded this proposition with-

out also conceding that a dividend received from a subsidi-

ary should be accorded the same tax treatment. Insofar as

there remains any ambiguity, since both the agreement

and the result in the Court of Claims represent exceptions

to the general rule that a mere decline in value does not

constitute a deductible loss, we construe them narrowly.

[14] Even assuming that the government’s concession

in Anderson, Clayton, supra, were on point, we would not

estop the Commissioner from seeking a result taxpayer

concedes would otherwise be the correct treatment of the

unrealized foreign exchange losses. Collateral estoppel ap-

plies only to an issue that was actually litigated and de-

termined in a prior action, not to an issue that might have

been litigated. This was not a case, moreover, in which the

issue with respect to which taxpayer seeks to estop the

B-42

government is necessarily implied by the prior judicial de-

cision even though not expressly decided. Once before the

Court of Claims, the government conceded the deductibility

of some foreign exchange losses but denied it as to others.

The court ordered judgment for taxpayer to the extent of

the government’s concession and judgment for the govern-

ment on the only point it contested.

[15] We start from the proposition that strong policy

considerations favor confining narrowly the scope of col-

lateral estoppel in tax cases. See Griswold, Res Judicata in

Federal Tax Cases, 46 Yale L.J. 1320 (1937). The most

persuasive policy consideration in the present context is

that perpetuation of an erroneous tax decision over a num-

ber of years would prejudice the losing party and violate

the policy of tax uniformity among taxpayers. 18 Moore’s

Federal Practice § 0.422(1) (2d ed. 1974). It is difficult to

think of a case in which according collateral estoppel effect

to a prior decision would more blatantly offend the policy

of tax uniformity. Whatever the precise nature of Ander-

son, Clayton, supra, it was decided under unique circum-

stances. Extending what taxpayer asserts to have been the

principle of that case would exempt Anderson, Clayton

from a requirement regarding the realization of foreign

exchange losses that all other taxpayers must bear.

[16] The chances that a court may reach an unsound

result that binds the taxpayer and the government and of-

fends the policy of tax uniformity are greatly increased

when the parties do not fully litigate the issue.*® When one

85 Adversary litigation is an important safeguard in the judicial

process. Thus, “neither the taxpayer nor the government should

be precluded from raising a relevant point of law unless it

appears beyond doubt that the precise point was actually con-

tested and decided (not merely assumed) in the prior litiga-

tion.” Pelham Hall Co. v. Hasset, 147 F.2d 63, 67 (1st Cir.

1945), quoted in 18 Moore’s Federal Practice § 0.422(2) (2d ed.

1974).

B-43

party to a tax case concedes or stipulates the issue upon

which the court bases its judgment, the issue is not conclu-

sively determined for purposes of collateral estoppel unless

it is clear that the parties

[609]

so intended. See 18 Moore’s Federal Practice § 0.444(4).

[17] In Umted States v. International Building Co., 345

U. S. 502, 73 S.Ct. 807, 97 L.Ed. 1182 (1953), the Court

held that tax judgments based on consent agreements be-

tween taxpayers and the government do not collaterally

estop litigation on the same issue for later tax years. In

that case decisions entered by the Tax Court were based

on stipulations that taxpayer owed no federal tax deficiency.

The Court said that unless the prior judgment was “an

adjudication on the merits, the doctrine of estoppel by judg-

ment would serve an unjust cause: it would become a device

by which a decision not shown to be on the merits would

forever foreclose inquiry into the merits.” Id. at 506, 73

S.Ct. at 809. This principle has been uniformly applied. See

United States v. Califorma Portland Cement Co., 413 F.2d

161, 163 (9th Cir. 1969) (collecting cases); cf. Seaboard

Air Line R. Co. v. George F. McCourt Trucking, Inc. 277

F.2d 593, 597 (5th Cir. 1960). Although there may be cases

in which a judgment entered with the consent of the parties

involves a determination of questions of fact and law by

the court the party seeking collateral estoppel effect has

the burden of proving this to be so. See United States v.

International Building Co. supra, 345 U.S. at 506, 73 S.Ct.

at 809. A fair reading of Anderson, Clayton, supra, dem-

onstrates that the court did not determine the question of

law for which taxpayer claims it stands.

[18] Finally, the taxpayer argues that we should not

apply the principle that a judgment based on stipulated or

B-44

conceded issues lacks collateral estoppel effect unless the

parties expressly indicate their intention not to be bound

in the future by the judgment. Anderson, Clayton points

out that in United States v. California Portland Cement Co.,

supra, the government had included such a statement in its

stipulations. Similarly in United States v. International

Building Co., supra, the government had made such a state-

ment in withdrawing from the bankruptcy proceeding that

preceded the Tax Court judgment, though no such dis-

claimer attached to its stipulations to the Tax Court. We

think the absence of such a disclaimer does not suffice to

show that the parties intended the judgment to have col-

lateral estoppel effect, a burden properly borne by the

party seeking such effect in litigation concerning differ-

ent taxable years. The presumption is that an issue resolved

by stipulation or concession in one suit is not conclusively

established in a subsequent suit on a different cause of

action unless it is clear that the parties so intended. See

18 Moore’s Federal Practice § 0.444(4).

VII.

The judgment of the district court with respect to the

sourcing of taxpayer’s Lausanne dividend for purposes of

calculating the per-country limitation on Anderson, Clay-

ton’s foreign tax credit is reversed and the cause remanded

for entry of an order consistent with this opinion. The

judgment of the district court regarding taxpayer’s claim

for a loss deduction arising from the decline in foreign

exchange value of promissory notes received as dividends

from its Argentine subsidiaries is affirmed.

AFFIRMED IN PART, REVERSED IN PART, AND

REMANDED.

C-1

APPENDIX C

tinh tied Cems

JUDGMENT OF THE UNITED STATES COURT

OF APPEALS

For THe Firra Circuit

NoveMBER 11, 1977

UNITED STATES COURT OF APPEALS

For Tue Firrx Crecuir

No. 75-2573

4 D. C. Docker No. CA 72-H-188

Anperson, Cirayton & Co.,

Plantiff-Appellee

Cross-Appellant,

Vv.

Unirep Srates or AMERICA,

Defendant-Appellant

Cross-A ppellee.

Appreats From Tue Unrrep Srates District Court For THe

SouTHERN District or Texas

Before TUTTLE, GOLDBERG and CLARK, Circuit

Judges.

C-2

JUDGMENT

This cause came on to be heard on the transcript of the

record from the United States District Court for the

Southern District of Texas, and was argued by counsel;

ON CONSIDERATION WHEREOF, It is now here or-

dered and adjudged by this Court that the judgment of

the said District Court in this cause be, and the same is

hereby, affirmed in part and reversed in part; and that

this cause be, and the same is hereby remanded to the said

District Court in accordance with the opinion of this Court;

It is further ordered that plaintiff-appellee cross-appel-

lant pay to defendant-appellant cross-appellee, the costs

on appeal to be taxed by the Clerk of this Court.

November 11, 1977

ISSUED AS MANDATE:

D-1

APPENDIX D

NOTICE OF ORDER DENYING PETITION FOR

REHEARING AND REHEARING EN BANC,

DecemBer 20, 1977

UNITED STATES COURT OF APPEALS

Fiera Crecurr

Orrice or Tue CLERK

December 20, 1977

TO ALL PARTIES LISTED BELOW:

NO. 75-2573 — Anvrerson, Ciayton & Co. v.

U.S.A.

Dear Counsel :

This is to advise that an order has this day been entered

denying the petition( ) for rehearing**, and no member

of the panel nor Judge in regular active service on the

Court having requested that the Court be polled on rehear-

ing en bane (Rule 35, Federal Rules of Appellate Pro-

cedure; Local Fifth Cireuit Rule 12) the petition( ) for

rehearing en banc has also been denied.

See Rule 41, Federal Rules of Appellate Procedure for

issuance and stay of the mandate.

Very truly yours,

EDWARD W. WADSWORTH,

Clerk

By Brenpa M. Havok

Deputy Clerk

**on behalf of appellee, Anderson, Clayton & Co.,

E-1

APPENDIX E

REVELANT PROVISIONS OF THE INTERNAL

REVENUE CODE OF 1954, AS AMENDED,

AND TREASURY REGULATIONS

Internal Revenue Code of 1954 (26 U.S.C.):

SEC. 901. TAXES OF FOREIGN COUNTRIES AND

OF POSSESSIONS OF UNITED

STATES.

(a) [as amended by Sec. 3(a) and (b), Act of Septem-

ber 14, 1960, P.L. 86-780, 74 Stat. 1010, and Sec. 12(b) (1),

Revenue Act of 1962, supra] ALLOWANCE OF CREDIT.

—If the taxpayer chooses to have the benefits of this sub-

part, the tax imposed by this chapter shall, subject to the

applicable limitation of section 904, be credited with the

amounts provided in the applicable paragraphs of subsec-

tion (b) plus, in the case of a corporation, the taxes deemed

to have been paid under sections 902 and 960. Such choice

may be made or changed at any time prior to the expiration

of the period prescribed for making a claim for credit or

refund of the tax against which the credit is allowable. The

credit shall not be allowed against the tax imposed by sec-

tion 531 (relating to the tax on accumulated earnings),

against the additional tax imposed for the taxable year

under section 1333 (relating to war loss recoveries), or

against the personal holding company tax imposed by sec-

tion 541.

(b) AMOUNT ALLOWED. — Subject to the applica-

ble limitation of section 904, the following amounts shall

be allowed as the credit under subsection (a):

(1) CITIZENS AND DOMESTIC CORPORA-

TIONS. — In the case of a citizen of the United States

and of a domestic corporation, the amount of any in-

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come, war profits, and excess profits taxes paid or

accrued during the taxable year to any foreign country

or to any possession of the United States; and

* « 7

SEC. 9022. CREDIT FOR CORPORATE STOCK-

HOLDER IN FOREIGN CORPORATION.

(a) [as amended by Sec. 9(a), Revenue Act of 1962,

supra] Treatment or Taxes Pam By Foreicn Corpora-

Tron. — For purposes of this subpart, a domestic corpo

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