Reply Brief — Reuters Ltd. v. Tax Appeals Tribunal

No. 93-1132

ieee

IN THE L—————- _-

Supreme Court of thenited States

OCTOBER TERM, 1993

REUTERS LIMITED

TAX APPEALS TRIBUNAL and

COMMISSIONER OF TAXATION AND FINANCE,

Respondents

PETITION FOR A WRIT OF CERTIORARI TO THE

COURT OF APPEALS OF THE STATE OF NEW YORK

REPLY BRIEF FOR PETITIONER

STEVEN ALAN REISS

Counsel of Record

PHILIP T. KAPLAN

DAVID B. GOLDSTEIN

WEIL, GOTSHAL & MANGES

767 Fifth Avenue

New York, New York LOIS3

(212) 310-8000

STUART H. SIMON

REUTERS AMERICA, IN¢

1700 Broadway

New York, New York 1OO19

(212) 603-3300

Attorneys for Petitioner Reuters Lumued

Dated: February 23, 1994

PRINTINGHOUSE PRESS

25 West 43rd Street New York, New York 10036 (212) 719-0990

II

l

TABLE OF CONTENTS

Page

REASONS FOR GRANTING THE PETITION . Lae

THE DECISION BELOW IS CONTRARY TO

THE TREATY 'S LANGUAGE, ITS INTERPRETATION

BY THE PARTIES, AND THE INTERPRETATION

OF IDENTICAL TREATY LANGUAGE vais 2

THE EXTRAORDINARY TAX COMPLIANCE BURDEN

DISCRIMINATES AGAINST REUTERS IN VIOLATION

OF THE TREATY AND THE FOREIGN COMMERCE

CLAUSE 8

THE NEW YORK FRANCHISE TAX REGULATIONS

FACIALLY DISCRIMINATE AGAINST FOREIGN

SOURCE INCOME IN VIOLATION OF THE FOREIGN

COMMERCE CLAUSE 9

CONCLUSION LO

il

TABLE OF AUTHORITIES

CASES: Page(s)

Barclays Bank PLC vy. Franchise Tax Bd., pet. for cert. granted,

SUG SCR SIP CIN 6 vce 5 eee )

Judgment of March 30, 1973, Finanzgerichte in Dusseldorf, 10

Entscheidungen der Finanzgerichte [EFG] 509 (F.R.G.) . 7

Judgment of November 18, 1985, Conseil D’ Etat (Fr.) .. . . . 6

Kraft General Foods, Inc. v. lowa Dep't of Revenue and Finance,

gre Fe Ba 206, : Ar 4,9, 10

New Haven Inclusion Cases, 399 U.S. 392 (1970) ...... \

OTHER:

Convention for the Avoidance of Double Taxation and the

Preventon of Fiscal Evasion with Respect to Taxes on

Income and Capital Gains, December 31, 1975 U.S.-U.K.,

OE AL. as OOOO. vs & 6b 5) 0 08 bere 2

Ant. 7(2) ee ar en ee ary 5

Art. 242) a ea Pree a he rt passim

I.R.S. Notice 89-80, 1989-2 C.B. 394... .. rE Oi

Third Protocol to the 1975 Income Tax Convention, as Amended,

U.S.-U.K., S. Exec. Doc. Q, 96th Cong.,

St eee: SETS ree fc ea kaa Ee ee 5

ili

MISCELLANEOUS:

3 British Tax Review 148 (1977) ................ 6

William C. Gifford, Permanent Establish Under the

Nondiscrimination Clause in Income Tax Treaties. ii

Comell Int'l] L.J.51 (1978) ......2..2. , ~

OECD Commitice Report on Fiscal Affairs, Model Double

Taxation Convention on Income and on

Capital (1977) i a

Klaus Vogel et al., Klaus Vogel on Double Taxation Conventions

j o

(199]) 7

No. 93-1132

IN THE

Supreme Court of the United States

OCTOBER TERM, 1993

REUTERS LIMITED,

Petitioner,

- Va.

TAX APPEALS TRIBUNAL and

COMMISSIONER OF TAXATION AND FINANCE,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

COURT OF APPEALS OF THE STATE OF NEW YORK

REPLY BRIEF FOR PETITIONER

Reuters Limited (“Reuters”), a United Kingdom company,

respecuully submits this reply brief in further support of its petition

lor a wntof ceruoran to review the judgment of the Court of Appeals

of the State of New York.

The Respondents’ brief in opposition (“Resp. Br.”) so

mischaractenzes the arguments raised in Reuters petition that it

fundamentally fails to address the issues actually before this Court.

To the extent that it does address issues actually raised by Reuters,

itimproperly relies on speculation about events that have never been

part of the record and on distortion beyond recognition of text, cases,

and commeritary. At bottom, respondents are unable to cite any

textual interpretation, judicial authority (other than the opinions

As a matter of styie, Reuters does not use the possessive form — Reuters’ —

‘ven where convenuon would use that form

2

below), or scholarly opinion that supports the Cour of Appeals’

interpretation of the nondiscrimination clause of the U.S.-U.K. Tax

Treaty. The holding below merits this Court's review because it

threatens to disrupt the orderly administration of intemational tax

law

REASONS FOR GRANTING THE PETITION

I. THE DECISION BELOW IS CONTRARY TO THE

TREATY’'S LANGUAGE, ITS INTERPRETATION BY

THE PARTIES, AND THE INTERPRETATION OF

IDENTICAL TREATY LANGUAGE

A. The State's fundamental mischaracterization is that Reuters

challenges the per se validity of the formula apportionment method

of taxation used by New York and by other states to tax the income

of foreign corporations. See Resp. Br. at 12. Reuters, however, has

never argued that the New York method of taxation is per se invalid

under the Treaty. See Petiuon for a Wnt of Certiorari (“Pet."’) at 3

n.3.~ What the permanent establishment nondiscrimination clause

of the Treaty does prohibit is the State placing a greater tax burden

on Reuters New York branch activities its permanent

establishment — than the State places on a local company engaged

in the same activities as Reuters permanent establishment. The

Clause does not limit the method or means of taxation; it does limit

the amount of the tax burden. It is only the application of the

formula apporuonment method of taxation to Reuters for the years

in question that is in issue

When Reuters New York branch — which lost money for the

years in question — is viewed properly as a separate enuty for the

purpose of measuring discrimination under Article 24(2), Reuters is

Clearly subjected to a greater tax burden than a local competitor. No

domestic company engaged in the same activities as Reuters New

York branch that lost money would be required to pay income tax

under these circumstances. See Pet. at 15

As Reuters stated in its opening bref, “the method of taxation does not figure

into the analysis of discrimination under Arucle 24(2)”; rather it is only the total

tax burden that is in issue. Pet. at 20-21 (emphasis im onginal)

3

Because the State focuses on the per se validity of its method of

taxation — not the discriminatory effect of the tax as it applies to

Reuters — it both misses the point of the permanent establishment

nondiscnmination clause and rarely addresses the issues in this case.

Worse, the State uses its mischaracterization of Reuters posiuion to

raise the alarm that a ruling for Reuters would invalidate the method

by which many states calculate corporate income tax. Resp. Br. at

|2-13. Because Reuters does not challenge New York's method of

laxing foreign corporations in general, the State's hyperbole is

incorrect ;

The State like the Court of Appeals commences its

argument by departing from the text of the Treaty. Thus, whereas

Article 24(2) of the Treaty refers to “|t}he taxation on a permanent

establishment,” the State and the court below argue that the drafters

must have meant taxation on the enterprise, of which the permanent

establishment (branch) is a part. Resp. Br. at 10; Appendix to the

Peuuion (“Pet. App.”), Sa-6a. Presumably, if the Treaty meant to

say that, it would have. The State's own argument, divorced from

the language of the Treaty, reveals that the Treaty means something

differemt than the State claims. As Reuters has explained, the

language “Laxavion on a permanent establishment” requires treating

the permanent establishment as a separate entity from the enterprise

Of which its a part, and comparing the tax burden on the permanent

establishment with “enterprises of that other State carrying on the

samc activities as the permanent establishment Treaty, Art. 24(2):

Pet. at 11-15.4

There is simply no textual suppor for the State's position,

adopted by the court below, that “the comparison required by the

\s Reuters has stated throughout these proceedings, New York taxes some

orporauions on the basis of formulary apporuonment and others

; eign banks. by the separate accountng method of income

nauon. See Bnef of Reuters in the Court of Appeals, at 44-46. New

York. however, has refused to allow Reuters W use the separate accounung

hod tor years in which the formula apportionment method produces a

Thus, the State's discourse on the meaning of “enterprises,” “residents,” and

3)

mporauor Resp. Br. at 10-11, 1s simply irrelevant for purposes of Article

wtuct omce™ned wilh taxauon on a permanent establishment

4

nondiscnmination clause is between a United States corporation

with a branch office in New York, viewed as a single business

enterprise, and a Bntish corporation with a branch office in New

York, also regarded as a single enterprise.” Resp. Br. at 11; Pet

App. 7a. This focus on the nationality of the taxpayer is improper.

Indeed, the OECD Commentary expressly states that the purpose of

the Treaty’s non-discrimination clause is “to end . . . discrimination

based not upon nationality but on the actual situs of the enterprise.”

OECD Committee Report on Fiscal Affairs, Model Double Taxation

Convention on Income and on Capital (‘OECD Repon”) 165

(1977)° (emphasis added); Pet. 11-14.

Quite simply, the local permanent establishment (branch) of a

foreign corporation cannot compete in a local market with a local

company if its costs of doing business are inflated by a tax burden

in excess of that placed on its local competitor competing in the same

market. Accordingly, the test for discnmination is to look at the tax

burden created by the activities of the branch and to compare it to

the tax burden created by the activities of a hypothetical local

company engaged in the same activities as the branch; if the tax

burden is greater, then the Treaty has been violated.

The focus of the State and the court below on the fact that a branch

iS NOt a separate taxable entity misses the point of the

nondiscnmination clause. Resp. Br. at 10-11; Pet. App. Sa-6a. That

clause asks whether Reuters cost of doing business in the local

market is being inflated by the State, not what legal entity actually

pays the tax. To be sure, Reuters could have formed a New York

subsidiary and avoided the discnmunatory tax, Pet. App. 15a, but,

as ths Court has made clear, a state cannot “force a taxpayer to

conduct its foreign business through a domestic subsidiary in order

to avoid discnminatory taxauon.” Kraft General Foods, Inc. v

Elsewhere, the State cites to this Commentary and concedes that “the important

factor is the situs of a corporation, not its nauonality.” Resp. Br. at 20. Although

the State claims this is not “pertinent to the present case,” id., it is in fact directly

contrary to the nationality-focused position taken by court below and the Siate

throughout these proceedings. Contrary w the State's asseruon, there is

absolutely nothing misleading in Reuters quotation from the OECD Report, at

165. See Pet. at 14

5

lowa Dep't of Revenue and Finance, _ U.S. _, 112 S.Ct. 2365, 2369

(1992); Pet. at 15.

B. The State’s extensive reliance on the legislative history to

show that the Treaty does not prohibit states from taxing foreign

nauionals by applying the formula apportionment method of taxation

to their worldwide income is simply irrelevant. Resp. Br. at 13-17.

As Reuters acknowledges, the treaty permits any method of taxation,

so long as ut does not discriminate in favor of local businesses.

The State deals with the single most important piece of legislative

history applicable to the aetual issues in this case by pretending that

it does not exist. As Reuters has noted, Pet. at 21, the Report of the

Senate Foreign Relations Commitiee on the Treaty makes clear:

Under the protocol, political subdivisions and loca!

authoniues of cither country are free to use formula

methods to apportion income, deductions and other

items among related enterprises in determining

income subject to their taxes, so long as such

methods do not violate the proposed treaty’ s

nondiscrimination provisions

Third Protocol to the 1975 Income Tax Convention, as amended,

LS.-U.K.. S. Exec. Doc. Q., 96th Cong., Ist Sess. 5 (1979)

(emphasis added). Thus, the State's claim that “[t}here is absolutely

no legislative history supporting petitioner's side of the argument,”

Resp. Br. at 16, 1s simply wrong

(. Unable to uncarth a single domestic or foreign opimon or

authority (other than the opinions below) to support its

misinterpretation of Article 24(2), the State resorts to denigraton

and distoruon of the authonties cited by Reuters. However, these

authontics make clear that the Contracting States, foreign courts,

and scholars have all taken the same position — discnminauon

under Article 24(2) is tested by looking at the permanent

establishment as if it were a separate enuty, and then determining

As previously noted, Pet. at 21 n.18, reliance on Article 7(2) of the Treaty is

placed because Reuters does not argue that Arucle 24(2) prohibits the

lormulary apporuonment method per se. Resp. Br. at 17-18; Pet. App. 8a.

6

whether the permanent establishment is subject to any greater tax

burden than a local competitor. Pet. at 15-20.

The U.S. Treasury Department, which negotiated the treaty on

behalf of the United States, has adopted precisely the view

advocated by Reuters here — in measuring discrimination under the

Treaty, the permanent establishment of a foreign taxpayer must be

viewed as a separate entity. I.R.S. Notice 89-80; Pet. at 16-17.

Notice 89-80 expressly states that the excess interest tax on a branch

does not violate Article 24(2) because, for purposes of Article 24(2),

the foreign company’s “branch is the functional equivalent. . . of a

subsidiary.” Notice 89-80, 1989-2 C.B. at 397; Pet. at 16. The

State's attempt to disunguish the Notice is not only unavailing, it

actually supports Reuters position. As the State is forced to

acknowledge, the Notice requires that the branch de treated like a

domestic subsidiary, Resp. Br. at 21-22, precisely the position

Reuters advocates.

U.K. Inland Revenue, which negotiated the treaty on behalf of

the United Kingdom, has taken the same view of the nondiscrimination

comparison as U.S. Treasury. Pet. at 17. Because the State cannot

argue with Inland Revenue’s position, it attempts to discredit

Reuters source material — the Inland Revenue letter submitted to

the British Tax Review. Resp. Br. at 22.’ The Inland Revenue letter

refers to an article published in the British Tax Review. See, J.

Oliver, Discrimination, 3 British Tax Review 148 (1977). The letter

states that the test for discnmination was properly described on page

151 of the article, which stated that the non-discnmination

comparison is made under Article 24(2) “by substituting for the

United Kingdom branch of the non-resident (United States)

corporation a United Kingdom resident company ....” 3 British

Tax Review at 151 (emphasis added). This is precisely the view

advocated by Reuters here.

The State also cannot deny that the French court (the Conscil

d’Etat), in Judgment of November 18, 1985, held that the proper

basis for comparison in testing discrimination under a provision

” The Inland Revenue letter was sent to J.D.B. Oliver, an Editor of the British Tax

Review, a leading expert on Bnush taxation, and a parmer at Coopers & Lybrand

in London.

BEE

j

identical to Article 24(2) is to look at the permanent establishment

as if it were a separate company. Resp. Br. at 23; Pet. at 18-19; Pet.

App. 62a-64a. The State further concedes that “some nations” have

adopted the French position. Resp. Br. at 23. The State then asserts

without citing a single example — that other nations have taken

contrary views. /d. The French decision is precisely on point, and

the State has no contrary authority to refute it.

The State attempts to deal with the German Court decision cited

by Reuters by confusing it beyond recognition. Resp. Br. at 24; Pet.

at 19, Pet. App. 57a-61a. That decision is actually quite

straightforward:

A German capital tax is not payable on transfers of

capital between branches of a German company.

However, under German tax law a capital tax was

payable on a transfer of capital between the German

branch of a Japanese company and its parent.

This tax did not violate the treaty because the

German branch of the Japanese company is viewed

as a separate enuty for the purpose of measuring

discrimination, and a separate German subsidiary

would have had to pay the tax.

The German decision is in accord with the positions taken by

Treasury, Inland Revenue, and the French Conseii d’Etat, in which

the test for discnmination requires that the permanent establishment

be treated as a separate entity, and that the tax burden arising out of

its aclivilies be compared to the tax burden on its local competitors.

The State is also unable to cite any scholarly writings to support

its interpretauon of Anicle 24(2). Both authorities cited by the State,

Resp. Br. at 11, 19 — Klaus Vogel, the leading commentator on

double taxauion conventions, and William C. Gifford — have taken

Reuters side. Klaus C. Vogel, Klaus Vogel on Double Taxation

*

In fact, he OBCD commentaries show that there is no division of opinion over

the basis tor comparison under the permanent establishment nondiscrimination

-lause; rather some countnes differ only on the consequences of that comparison

in the context of intra-company dividends. OECD Report, at 168.

8

Conventions at 132 (1991); William C. Gifford, Permanent

Establishments Under the Nondiscrimination Clause in Income Tax

Treaties, 11 Comell Int'l. L.J. 51, 61 (1978) (Reuters position “is

consistent with the purposes of the provision as stated in the 1977

commentary to the OECD Model Treaty, namely to end

discrimination in the treatment of permanent establishments as

compared with resident enterprises involved in similar operations’);

Pet. at 19-20 n.17.

Il. THE EXTRAORDINARY TAX COMPLIANCE

BURDEN DISCRIMINATES AGAINST REUTERS IN

VIOLATION OF THE TREATY AND THE FOREIGN

COMMERCE CLAUSE

Respondent's brief is replete with unsubstantiated assertions that

Reuters State tax filings for the previous sixty years must have

conformed to New York's unique tax requirements, and there fore

Reuters evidence of compliance and start-up costs is not credible.

Resp. Br. at 5-7, 24-28. Yet the only evidence in the record on the

burden of compliance is from Reuters, and that evidence shows the

cost of compliance is, indeed, crushing. The State’s argument is

based exclusively on speculation about events outside the record,

which says nothing about Reuters method of filing its retums from

1917 to 1976 or the burden of recasung Reuters woridwide accounts

to conform to New York requirements dunng the earlier years of its

presence in New York — years in which New York tax reporung

had not yet reached its present level of complexity. Pet. at 22-23.

Indeed, the only evidence in this case is that Reuters submitted

nonconforming accounts in 1977, which the State chose to accept in

the context of this case. Pet. at 6, 22.

The cost of providing noncomplying data is not in issue. The cost

of providing comptving data is. The uncontroverted record evidence

shows that the burden on Reuters to maintain data in accordance

with New York law in all of its operations around the world would

be approximately $1,000,000 annually — and, indeed, would dwarf

the tax. Pet. at 22-23. This case must be decided on the record, not

on speculation and innuendo. New Haven Inclusion Cases, 399

U.S. 392, 450 n.66 (1970).

9

The State acknowledges that a similar compliance cost issue is

betore this Cour in Barclays Bank PLC v. Franchise Tax Board,

cert. granted, U.S. __, 114 S.Ct. 379 (1993), but relies solely on

speculation about occurrences outside the record to argue that a

ruling in Barclay’s favor would be inapplicable to Reuters. The

actual] evidence in this case, however, demonstrates that the onerous

compliance costs violate Article 24(2) and the Foreign Commerce

Clause. Pet. at 21-23.

Ill. THE NEW YORK FRANCHISE TAX REGULATIONS

FACIALLY DISCRIMINATE AGAINST FOREIGN

SOURCE INCOME IN VIOLATION OF THE FOREIGN

COMMERCE CLAUSE

The State completely misunderstands Reuters contention that

New York's scheme is constitutionally infirm under Kraft, supra,

because it discnminates against foreign source income. Kraft, 112

S.Ct. at 236%-70; Pet. at 23-25. Instead, the State's only response is

that it does not impose different burdens on foreign and domestic

subsidiaries — an observation completely irrelevant to whether the

State Laxes income differently depending upon whether it is from a

foreign or domestic source. Resp. Br. at 28-29. The Foreign

Commerce Clause issue raised by Reuters under Kraft challenges

the way “entire net income” is computed under New York law by

adding foreign source income, but not domestic source income, to

federal taxable income (which is the starting point for New York

taxauon). Pet. at 24-25. Reuters does not challenge the facial

validity of the formula apportionment method of taxation or

disparate treatment of domestic and foreign subsidiaries, as the State

mistakenly contends. New York law clearly discnminates against

foreign source income in computing “entire net income.” Pet. at

24-25. This discnminaticn is patently unconstitutional under Kraft

No showing of discrimination against foreign nationals is required

under Kraft, which involved the taxation of the U.S. parent, not its

foreign subsidiaries. Kraft, 112 S.Ct. at 2367, 2370-72. The

consutuuonal violation anses solely from the discnminatory

ireatment of foreign source income, regardless whether the State is

acung pursuant to a discnminatory motve or whether it taxes

10

foreign and domestic corporations differently.”

CONCLUSION

For the reasons stated herein and in the petition, the petition for

a wit of certiorari should be granted.

Dated: February 23, 1994

Respectfully submitted,

Steven Alan Reiss

Counsel of Record

Philip T. Kaplan

David B. Goldstein

Weil, Gotshal & Manges

767 Fifth Avenue

New York, New York 10153

(212) 310-8000

Swart H. Simon

Reuters America Inc.

1700 Broadway

New York, New York 10019

(212) 603-3300

Attorneys for Petitioner

Reuters Limited

: Although this Court stated that lowa “imposes a burden on foreign subsidiaries

that it does not impose on domestic subsidiaries,” Kraft, 112 S.Ct. at 2371, the

Foreign Commerce Clause violation in Kraft involved not a discnminatory

taxation of foreign subsidiaries, but taxation of a domestic corporation thal

discriminated against foreign commerce by taxing certain foreign source income,

but not identical domestic source income. /d. at 2370; ~

a