Appendix — Thomas International Ltd. v. United States, 9 Cl. Ct. 1261 (1986) (No. 85-879)

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Supreme Court, U.S.

@5-879 | FLLED

No, ———___ NOV 18 (98S

JOSEPH & SPANIOL, JR.

CLERK

IN THE

Suprenve Court of the United States

OCTOBER TERM, 1985

es

THOMAS INTERNATIONAL LIMITED,

Petitioner

Vv.

THE UNITED STATES,

Respondent

SUPPLEMENTAL APPENDIX TO

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FEDERAL CIRCUIT

MICHAEL D. GUNTER

Counsel of Record

WOMBLE CARLYLE SANDRIDGE

& RICE

Post Office Drawer 84

Winston-Salem, N.C. 27102

Telephone: (919) 721-3607

Of Counsel:

WILLIAM C. RAPER

ALICE M. PETTEY

WOMBLE CARLYLE SANDRIDGE

& RICE

Post Office Drawer 84

Winston-Salem, N.C. 27102

Telephone: (919) 721-3600

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November 21, 1985 Attorneys for Petitioner

WILSON - EPES PRINTING Co., INC. - 789-0096 - WASHINGTON, D.C. 20001

SA-1

IN THE UNITED STATES CLAIMS COURT

No. 449-81T

THOMAS INTERNATIONAL LIMITED

Vv.

THE UNITED STATES

I.R.C. §§ 991-97 Domestic International Sales

Corporation (DISC); Commissions Receivable

from a related supplier as qualified export as-

sets; Authority of Commissioner to issue regu-

lations under I.R.C. § 7805; Treas. Reg. § 1.993-

(2) (d) (2) invalid as not authorized by statute.

(Filed October 12, 1984)

Michael D. Gunter, Winston-Salem, North Carolina, at-

torney of record for plaintiff. Thomas L. Kummer, Alice

M. Pettey and Womble, Carlyle, Sandridge & Rice, of

counsel.

Mary M. Abate, Washington, D.C., with whom was As-

sistant Attorney General Glenn L. Archer, Jr., for defend-

ant. Theodore D. Peyser, of counsel.

OPINION

ON CROSS-MOTIONS FOR SUMMARY JUDGMENT

MILLER, Judge:

This suit is for refund of corporate income taxes paid

for the years 1977 and 1978.

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Internal Revenue Code (I.R.C.) §§ 991-97 provides for

deferred tax treatment of income from foreign sales con-

ducted through an intermediary corporation known as a

Domestic International Sales Corporation, or DISC. I.R.C.

§ 992(a) provides, inter alia, that for a corporation to

be a DISC it must own qualified export assets, the ad-

justed basis of which at the close of its taxable year

equals or exceeds 95 percent of the sum of the adjusted

basis of all of its assets; and §9938(b) provides that

qualified export assets include accounts receivable. The

question at issue is whether or not the Treasury is au-

thorized to provide by reguiation that an account receiv-

able representing accrued commissions payable to the

DISC by its related supplier in connection with the sale

of export property is includible in qualified export assets

only if such commissions are paid no later than 60 days

after the close of the taxable year.

Facts

Plaintiff, Thomas International Limited (hereinafter

TIL), is a wholly owned corporate subsidiary of Thomas

Built Buses (hereinafter TBB). TBB is engaged in the

business of manufacturing and selling buses. TIL was

organized by TBB in 1973 to qualify as a DISC, and TIL

elected such treatment from and after its first taxable

year. During the taxable years at issue, TIL engaged

exclusively in export related activities.

On July 1, 1973, TIL and TBB executed a written sup-

plier’s agreement whereby TIL would serve as a “com-

mission DISC” in conformity with the Internal Revenue

Code and Treasury Regulations. As a commission DISC,

plaintiff accrued a commission from TBB on all export

sales made by TBb. The amount of the commission was

determined under the “50-50 combined taxable income

method (described in § 994(a) (2), discussed infra).

For the taxable years ending March 31, 1977 and 1978,

TBB reported sales of export property yielding taxable

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income of $1,416,462 and $658,114, respectively. TIL ac-

cumulated entitlement to gross commissions with respect

to these export sales, of $708,231 in 1977, and $329,057

in 1978. These commissions were properly accrued as ac-

counts receivable in the books of TIL on March 31, 1977

and 1978, respectively. However, TBB did not actually

pay such commissions to TIL until December 15, 1977,

and June 1, 1978, respectively.

Plaintiff reported on its federal income tax returns

DISC taxable income of $665,737 for its taxable year

ended March 31, 1977, and $307,640 for its taxable year

ended March 31, 1978. However,because of its claim to

qualification as a DISC, it paid no taxes for either year.

On January 9, 1981, the Jr‘ternal Revenue Service

(I.R.S.) issued notices of deficic. jes to TIL stating its

determiation that TIL did not qualify as a DISC for the

taxable years ending in 1°77 and 1978, because, at the

end of these taxable years, the adjusted basis of the quali-

fied export assets owned by TIL did not equal or exceed

95 percent of the sum of the adjusted basis of all assets

held by TIL, as-vequired by § 992(a)(1)(B). The reason

underlying the determination was that the commissions

receivable by plaintiff from TBB for 1977 were not paid

to it until 8'4 months after the close of that taxable year

and for 1978 until 62 days after the close of that year.

Plaintiff paid the assessed deficiency and filed claims

for refund. On April 3, 1981, the I.R.S. disallowed TIL’s

claims and plaintiff timely filed this suit on July 20, 1981.

The General DISC Statutory Scheme

The DISC provisions, I.R.C. $$ 991-97, were originally

added to the Code by the Revenue Act of 1971 (Pub. L.

No. 92-178, Title V, § 501, 85 Stat. 535). The purpose of

the legislation was explained as follows:

[I]t is important to provide tax incentives for U.S.

firms to increase their exports. This is important not

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only because of its stimulative effect but also to re-

move a present disadvantage of U.S. companies en-

gaged in export activities through domestic corpora-

tions. Presently, they are treated less favorably than

those which manufacture abroad through the use of

foreign subsidiary corporations. United States cor-

porations engaging in export activities are taxed

currently on their foreign earnings at the full U.S.

corporate income tax rate regardless of whether these

earnings are kept abroad or repatriated. In contrast,

U.S. corporations which produce and sell abroad

through foreign subsidiaries generally can postpone

payment of U.S. tax on these foreign earnings so long

as they are kept abroad.

In addition, other major trading nations encourage

foreign trade by domestic producers in one form or

another. * * * Both to provide an inducement for

increasing exports and as a means of removing dis-

crimination against those who export through U.S.

corporations, your committee’s bill provides a de-

ferral of tax where corporations meeting certain con-

ditions—called Domestic International Sales Corpora-

tions—are used.

(H.R. Rep. No. 533, 92d Cong., Ist Sess. 58 (1971),

reprinted in 1972-1 C.B. 498, 529; and see also S. Rep.

No. 437, 92d Cong., 1st Sess. 90 (1971), reprinted in

1972-1 C.B. 559, 609.)

In general, the profits of a DISC are not taxed to the

DISC, but, prior to enactment of the Deficit Reduction

Act of 1984 ' were to be taxed to its corporate shareholder

when distributed or deemed distributed. I.R.C. § 991.

The DISC is not required to have any employees or pay-

roll. Its orders may be solicited by the parent corpora-

tion’s sales force, in the parent’s name, and collections

1 Act of July 18, 1984, § 805(b) (2) (A), Pub. L. No. 98-369, 98

Stat. 494, 1001 (to be codified at 26 U.S.C. § 991 note).

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may also be handled directly by the parent. The parent

may impute to the DISC either the proceeds of the ex-

port sales or commissions on such sales. I.R.C. § 994

(b) (1); Treas. Reg. § 1.993-1(1) (1977). As the court

stated in Caterpillar Tractor Co. v. United States, 218

Ct. Cl. 517, 525-26, 589 F.2d 1040, 1044 (1978):

a DISC is permitted to be no more than a shell cor-

poration with no employees, the only purpose of

which is to act as an accounting vehicle for the

earnings of its affiliated or parent corporation * * *

which is designed to permit the deferral of a portion

of an enterprise’s profits from the exportation of

products as long as the DISC is in existence.

I.R.C. § 992 prescribes the statutory qualifications for

a DISC, included among which are that 95 percent or

more of the DISC’s gross receipts must consist of quali-

fied export receipts, and that at the close of its taxable

year the adjusted basis of the corporation’s qualified ex-

port assets must equal or exceed 95 percent of the ad-

justed basis of all of its assets.

I.R.C. § 993 provides the definitions for qualified ex-

port receipts and qualified export assets. Insofar as perti-

nent, qualified export receipts are those from the sale of

export property and for services related and subsidiary

to any qualified export property for ultimate use outside

the United States. I.R.C. § 993(a). Likewise, insofar as

pertinent, qualified export assets refers generally to prop-

erty produced in the United States for sale or rental in

the ordinary course of business outside the United States.

I.R.C. § 993(b). In the case of commissions on the sale

of property, the amount taken into account as gross re-

ceipts are the gross receipts on the sale or rental of the

property on which the commissions arose. I.R.C. § 993(f).

I.R.C. § 994, entitled “Inter-company Pricing Rules”,

prescribes the standard for the allocation of income be-

tween the related corporations. Under § 994(a) the tax-

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able income of the DISC is to be based on a transfer

price from the shareholder-supplier which would allow the

DISC to derive income from the sale of the property in an

amount which does not exceed the greater of: (1) 4 per-

cent of the qualified export receipts on the sale of the

property by the DISC plus 10 percent of the export pro-

motional expenses attributable to the DISC; (2) 50 per-

cent of the combined taxable income of the DISC and the

supplier plus 10 percent of the DISC’s attributable export

promotional expenses; or (3) income based upon the sale

price actually charged by the supplier to the DISC (but

subject to adjustment pursuant to § 482).

I.R.C. § 994(b) also directs the Secretary of the Treas-

ury to prescribe regulstions setting forth “rules which

are consistent with the rules set forth in subsection (a)

for the application of this section in the case of commis-

sions, rentals and other income.” Pursuant to this au-

thority, in Treas. Reg. § 1.994-1/d) (2), the Secretary has

prescribed that if any transaction to which LR.C. $994

applies is handled en a commission basis for a related

supplier by a DISC and such commissions give rise to

qualified export receipts, the amount of the income which

may be allocated as earned by the DISC is the amount

which under § 994(a) the DISC would have been per-

mitted to earn if the related supplier had sold the prop-

erty to the DISC and the DISC in turn had sold it to a

third party.

I.R.C. § 995, which deals with “Taxation of DISC In-

come to Shareholders”, prescribes the portion of the DISC

income which is initially taxable to its shareholders each

year and the applicable conditions and times when the

remainder of the DISC income becomes taxable to them

either because it is actually distributed or it is deemed

distributed whether or not it is actually done.

Discussion

Pursuant to the regulatory authority set forth in

§ 994(b), Treas. Reg. § 1.994-1 implements the provisions

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of I.R.C. § 994 for allocating income between DISC and

related supplier as follows:

$994. IJnter-company pricing rules

(e) Method of applying paragraphs (c) [Transfer

price for sale of export property] and (d) [Rules

under section 994(a){1) and (2) for transactions

other than sales] of this section—

* * * *

(3) Initial payment of transfer price or com-

mission. (i) The amount of a transfer price (or

reasonable estimate thereof) actually charged by

a related supplier to a DISC, or a sales commis-

sion (or reasonable estimate thereof) actually

charged by a DISC to a related supplier, in a

transaction to which section 994 applies must be

paid no later than 60 days following the close of

the taxable year of the DISC during which the

transactions occurred.

Although neither LR.C. § 992(a)(1) (which requires

that the adjusted basis of the qualified export assets at

the close of the year equal or exceed 95 percent of the

total asset basis) nor §$ 993(b) (which defines “qualified

export assets” to include, inter alia, “accounts receivable

* * * which arise by reason of transactions of such cor-

poration”) contains authority similar to that in § 994 for

the issuance of regulations, nevertheless the Secretary has

prescribed regulations under § 993 that trade receivables

representing commissions due from unrelated principals

may be treated as qualified export assets but that those

due from related suppliers are not to be so treated unless

paid within 60 days after the close of the year, to wit

(Treas. Reg. § 1.993-2(d)):

(2) Trade receivables representing commissions.

If a DISC acts as commission agent for a principal

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in a transaction described in § 1.9938-1(b), (ec), (d),

fe), (h), or (i) which results in qualified export

receipts for the DISC, and if an account receivable

or evidence of indebtedness held by the DISC and

representing the commission payable to the DISC as

a result of the transaction arises * * * such account

receivable or evidence of indebtedness shall be treated

as a trade receivable. Jf, however, the principal is a

related supplier (as defined in § 1.994-1(a)(3)) with

respect to the DISC, such account receivable or evi-

dence of indebtedness will not be treated as a trade

receivable uvless it is payable and paid in a time

and manner which satisfy the requirements of § 1.994-

1(e)(3) * * *. (Emphasis added. )

Plaintiff claims that the § 1.993-2(d)(2) regulatory

exclusion from qualified assets at the close of the year

of an account receivable representing commissions due

from a related supplier merely because they were paid

more than 60 days after the close of the year is un-

authorized, arbitrary, legislative in character and con-

trary to the DISC statute.

Defendant relies wholly upon the reasoning of the Tax

Court in CWT Farms v. Commissioner, 79 T.C. 1054

(1982) (appeal docketed, No. 84-8012 (11th Cir. Jan. 4,

1984)" to sustain the validity of the regulation. There

the court found authority for the regulation in I.R.C.

$ 7805(a) which generally authorizes the Secretary of

the Treasury to “prescribe all needful rules and regula-

tions for the enforcement of” the revenue statutes. It

noted that the inquiry of the courts is “generally limited

to the question whether the regulation implements the

congressional mandate in some reasonable manner * * *,

* Also followed in Fritzche Dodge & Olcott, Inc. v. Commissioner.

45 T.C.M. 607 (1983) and LeCroy Research Systems Corp. v. Com-

missioner, 47 T.C.M. 1345 (1984), appeal docketed, No. 84-4062

(2d Cir. Apr. 25, 1984).

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or in other words, whether the challenged regulation

harmonizes with the plain language of the statute, its

origin, and purpose.” CWT Farms, 79 T.C. at 1061-62.

It held the challenged regulation to be a permissible

interpretation of the language of § 993(b) (3) because

it found such language to be “anything but unambig-

uous.” Jd. at 1063.

Seetion 993(b)(3) provides in pertinent part that—

the qualified export assets of a corporation are—

(3) accounts receivable * * * which arise by

reason of transactions of such corporation * * * de-

scribed in subparagraph (A), (B), (C), ‘D), (G)

or (H), of subsection (a) (1).

The transactions referred to in subparagraph (A) are

“the sale, exchange, or other disposition of export prop-

erty.”

The Tax Court thought that since the qualified ac-

counts receivable are those “which arise by reason of

transactions [sales] of such corporation {the DISC]”,

and a commission DISC has no sales of its own the “ac-

counts receivable” in question is susceptible of an inter-

pretation excluding those of a commission agent. Hence,

the Tax Court reasoned, “the extent to which Congress

intended commissions receivable owed by the producer

to the related DISC to constitute qualified export assets

is unclear * * * [and] the challenged regulation can

in no way be said to contradict or limit the ‘unambigu-

ous’ language of section 993 (b) (3).”

However, in the light of the entire statute this court

finds the alleged ambiguity to be more apparent than

real. That Congress intended te allow a DISC to operate

as a commission agent as We a reseller of goods and

services is implicit in § 993(1:. which defines the term