# Petition for Writ of Certiorari — Archer-Daniels-Midland Co. v. United States

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 1995
- **Citation:** 514 U.S. 1077

## Text

941261 JAN 2 5 1995

N
™ OFFICE OF JHE cep,

In THE
Supreme Court of the United States

OCTOBER TERM, 1994

ARCHER-DANIELS-MIDLAND COMPANY, on its own behalf
and as common parent of an affiliated group of corpo-
rations, FILEISCHMANN-KURTH MALTING COMPANY,
INCORPORATED, and COEVAL, INCORPORATED,

¥, Petitioners,
UNITED STATES OF AMERICA,
Respondent.

Petition for a Writ of Certiorari to the
United States Court of Appeals
for the Seventh Circuit

PETITION FOR A WRIT OF CERTIORARI

JOSEPH ANGLAND *

FELIX B. LAUGHLIN

DAVID E. WATTS

DEWEY BALLANTINE

1301 Avenue of the Americas
New York, NY 10019-6092
(212) 259-8000

A. JAMES SHAFTER

KEHART, SHAFTER, HUGHES
& WEBBER, P.C.

Suite 500

First of America Center

P.O. Box 871

Decatur, IL 62525-0871

(217) 428-4689

Attorneys for Petitioners
* Counsel of Record

WILSON - Eras Printine Co., Inc. - 789-0096 - WASHINGTON, D.C. 20001

QUESTIONS PRESENTED

1. Can a clear statutory provision be overridden by
an equally clear but inconsistent statement in congres-
sional committee reports?

2. In determining whether statutory language has more
than one plausible interpretation, can an interpretation
be deemed plausible if it involves reading an introduc-
tory clause to imply a limitation on the first of the three
mathematical formulae it governs when it is undisputed
that the limitation should not be applied to the third
formula?

(i)

il

RULE 29.1 STATEMENT

The parents and subsidiaries (other than those that
are wholly owned or otherwise not publicly held) of the
parties to the proceeding in the lower courts are:

Acatos & Hutcheson Plc.
American Maize-Products Co.
Overseas Shipholding Group, Inc.
Pilgrims Pride Corporation

i Preity i id ea a aes NI Goer

TABLE OF CONTENTS

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STATUTORY AND REGULATORY PROVISIONS
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B. ADM’s DISC Transactions .................................... 4
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REASONS FOR GRANTING THE PETITION .......... 7

I. THE PETITION SHOULD BE GRANTED TO
OVERRULE THE HOLDING THAT LEGIS-
LATIVE HISTORY CAN OVERRIDE THE |
LANGUAGE OF A STATUTE THAT IS COM-
oP bs | os) Sn 9

II. THE PETITION SHOULD BE GRANTED TO
ESTABLISH THAT AN INTERPRETATION
OF A STATUTE THAT LEADS TO INTER-
NAL CONTRADICTIONS IS NOT PLAUSI-
at i schseaeieione 13

Ill. THIS CASE IS A PARTICULARLY APPRO-
PRIATE VEHICLE FOR CLARIFYING THE
PERTINENT LEGAL PRINCIPLES ................. 17

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TABLE OF AUTHORITIES
CASES Page
Atkins v. Parker, 472 U.S. 115 (1985) ......0.0..0002..... 9
Brown v. Gardner, 115 S. Ct. 552 (1994) ....0.200000... 14,15
Edwards v. Valdez, 789 F.2d 1477 (10th Cir.
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G.U.R. Co. v. Commissioner, 117 F.2d 187 (7th
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APPENDIX A

IN THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT

No. 93-3939

ARCHER-DANIELS-MIDLAND COMPANY, on its own behalf
and as common parent of an affiliated group of corpo-
rations, FLEISCHMANN-KURTH MALTING COMPANY,
INCORPORATED, and COEVAL, INCORPORATED,

Plaintiffs-A ppellees,
V.

UNITED STATES OF AMERICA,
Defendant-A ppellant.

Appeal from the United States District Court
for the Central District of Illinois, Danville Division
No. 89 C 2325—Harold A. Baker, Judge

ARGUED May 17, 1994—DeEcipDED OCTOBER 3, 1994

Before PosNER, Chief Judge, and HILL* and RIPPLE,
Circuit Judges.

POSNER, Chief Judge. The district judge ordered the
government to refund some $18 million in taxes (plus a
good deal of interest, since the taxable years in suit are

* Hon. James C. Hill of the Eleventh Circuit, sitting by desig-
nation.

2a

1975 through 1978) to Archer-Daniels-Midland, the agri-
cultural giant; and the government appeals. The quarrel
is over the meaning of the “DISC” provisions of the Inter-
nal Revenue Code, 26 U.S.C. §§ 991-997, which allowed
exporters such as ADM to defer federal income tax on
income (or, as ADM would have it,- on gross receipts in
some cases) obtained from those exports. We say “al-
lowed” (past tense) because these provisions have been
superseded by the provisions on Foreign Sales Corpora-
tions, 26 U.S.C. §§ 921-27; see 2 Joseph Isenbergh, Jn-
ternational Taxation: U.S. Taxation of Foreign Taxpay-
ers and Foreign Income 4 33.3 (1990), though issues
similar to those in this case may arise under the successor
provisions as well. See 26 C.F.R. § 1.925(a)-1T(e) (1).

Here is how the tax shelter, created in 1971 to stimu-
late agricultural exports (though not limited to such ex-
ports), worked. The exporter creates a DISC (Domestic
International Sales Corporation), which is simply an ac-
counting entity that has the happy property of not being
subject to federal income tax, although some of its income
is taxed to the DISC’s owner (in this case ADM) at once
and the rest is taxed to him later. The DISC’s income is
determined by the price at which the owner (called a
“related supplier”) transfers output to it for sale abroad
nominally by the DISC. The tax benefits of exporting
through a DISC would be maximized if the owner could
set a transfer price of zero, for then his entire export
income would be attributed to the DISC. Congress didn’t
want to go that far to stimulate exports, so it provided
in 26 U.S.C. § 994(a) that the taxable income of the
DISC and of the DISC’s owner “shall be based upon a
transfer price which would allow such DISC to derive i
taxable income attributable to such [export] sale (regard- \
less of the sale price actually charged) in an amount
which does not exceed the greatest of—” and three al-
ternatives are listed. Only two need be discussed. The
second—logically the first as it seems to us, since the
statute is designed to shelter income made in export sales

hearers

3a

—is 50 percent of “the combined taxable income of the
DISC and [its owner] which is attributable to the” export
sale, plus some expenses which we can ignore. § 994
(a)(2). The first—logically the second because it is de-
signed to provide a benefit when the income from the
export sale is too slight to yield a substantial benefit
under the first subsection—is “4 percent of the qualified
export receipts on the sale of property by the DISC” plus,
again, certain expenses that we can ignore. § 994(a)(1).
ADM argues, and the district court agreed, 798 F. Supp.
505 (C.D. Ill. 1992), that this subsection allows it to
set a transfer price that will give the DISC taxable in-
come (taxable to the DISC’s owner that is, with some of
the tax deferred) equal to 4 percent of ADM’s gross re-
ceipts from agricultural exports.

The Treasury Department disagrees. In an interpretive
regulation that the district court invalidated, 26 C.F.R.
§ 1.1994-1(e)(1)(i), the Department takes the position
that subsection (1) of section 994(a) in effect supple-
ments subsection (2). Subsection (2) allows the exporter
to shift half its export income to the DISC; but should
its total income, and therefore one half of that total, be
meager (it might be zero), it can use subsection (1) to
shield a percentage of its gross receipts (a larger figure
than income) up to 4 percent. So, for example, if the
exporter has sales of $100, and income of $10, it can
shift $5 to the DISC via subsection (2), because $5 is
50 percent of $10. But if its income were only $6, it
could shift $4 to the DISC by using subsection (1) in-
stead, since $4 is 4 percent of $100. That is under the
regulation. But under ADM’s and the district judge’s
interpretation, even if the combined income of the DISC
and its owner is zero or even negative, the owner can still
shift income equal to 4 percent of its export sales to the
DISC—provided that it has income elsewhere in its busi-
ness, for otherwise the maneuver would confer no benefit
on it.

4a

Suppose, then, that ADM had just two divisions, and
one exported agricultural products and the other manu-
factured children’s toys for sale in the United States, and
the first just broke even and the second was profitable;
the first had gross receipts of $100, costs of $100, and
income therefore of zero (so that subsection (2) would be
worthless to it), and the second had income of $10 (its
gross receipts and costs are irrelevant). ADM would fix
a transfer price to the DISC of $96, generating income
of $4 for the DISC, that being 4 percent of ADM’s gross
receipts from exports. Since ADM’s total income is in
fact only $10 in this example, none of it export income,
the effect of its maneuver would be—if ADM’s interpreta-
tion of the statute is sustained—to obtain favorable tax
treatment for 40 percent of its domestic income.

ADM is right to point out that the basic purpose of
the DISC program—the encouragement of agricultural
exports—would be served by such an interpretation, be-
cause it would encourage unprofitable as well as profit-
able, exports, whereas the Treasury Department’s inter-
pretation would encourage only the profitable ones. But
reference to purpose cannot be conclusive in a case, such
as this, where neither interpretive alternative would thwart
the statute’s purpose and the issue rather is how far the
legislature wanted to go in subordinating competing pur-
poses, such as the raising of government revenues by tax-
ation. Under either interpretation, exports are encour-
aged; they are encouraged more by the taxpayer’s inter-
pretation than by the tax collectors’; but the question is
whether Congress legislated that degree of encouragement.
Rodriguez v. United States, 480 U.S. 522, 525-26 (1987)
(per curiam); Stomper v. Amalgamated Transit Union,
No. 93-3468, slip op. at 6-7 (7th Cir. June 22, 1994);
Bushendorf v. Freightliner Corp., 13 F.3d 1024, 1026
(7th Cir. 1993). Perhaps mindful that reference to pur-
pose is inconclusive in a case such as this, ADM argues
that its interpretation is also compelled by, rather than
merely being consistent with, the statutory language. It

Sa

is not compelled. The exporter is allowed to fix a transfer
price that will allow its “DISC to derive taxable income
attributable to [the export] sale,” 26 U.S.C. § 994(a),
and in our hypothetical sale ADM has no income from
its export sales. To read section 994(a) as implying that
the 4-percent-of-gross-receipts method of calculating DISC
income in subsection (1) is capped at the amount of
taxable income derived from export sales is not inevitable,
but it is plausible, and it is supported by the legislative
history. Both committee reports describe the 4 percent
of gross receipts method as a way of calculating a ceiling
on allowable income. H.R. Rep. No. 533, 92d Cong.,
Ist Sess. 74 (1971); S. Rep. No. 437, 92d Cong., Ist Sess.
107 (1971). Legislative history is in bad odor in some
influential judicial quarters, see, e.g., United States v.
Taylor, 487 U.S. 326, 344-46 (1988) (concurring opin-
ion) but it continues to be relied on heavily by most
Supreme Court Justices and lower-court judges; and in
the case of statutory language as technical and arcane as
that of the DISC provisions, the slogan that Congress
votes on the bill and not on the report strikes us as pretty
empty. Even advised by his personal staff a member of
Congress would have great difficulty figuring out the pur-
port of 26 U.S.C. § 994(a)(1) without the aid of the
committee reports. If he (or his staff) cannot rely on
them as a guide to the meaning of the statute, we are not
sure what he is supposed to do.

Interpreted as ADM would interpret it, subsection (1)
would have potentially far-reaching effects that we hesitate
to impute to Congress without evidence that they were
intended—effects such as encouraging —purely domestic
businesses to acquire export subsidiaries as tax shelters.
A more plausible office to attribute to the subsection is
that of serving as a complement to the next subsection.
The exporter who has a low profit margin can use subsec-
tion (1) to shelter income up to 4 percent of his sales and
the exporter with a high profit margin can use subsection

6a

(2) to shelter up to half his profits without regard to his
total sales. Evenhanded treatment of low-margin and high-
margin exporters is achieved. The statute could be clearer
but in light of the considerations that we have discussed it
adequately supports the Treasury’s regulation, to which
we are supposed to accord a certain amount of deference
even when as in this case it is “interpretive”—promulgated
pursuant to the Treasury’s general rulemaking authority—
rather than being “legislative” in the sense of having been
promulgated pursuant to a specific grant by Congress of
authority to regulate the area in question. Cottage Savings
Ass'n v. Commissioner, 499 U.S. 554, 560-61 (1991);
Gehl Co. v. Commissioner, 795 F.2d 1324, 1328-29 (7th
Cir. 1986).

The judgment for ADM is therefore

REVERSED.

Ta
HILL, J., dissenting dubitante:

At the outset, I make two acknowledgments. First, if
the Secretary of the United States Treasury Department
has the authority, in the form of regulation, to modify the
Congressional statute before us by executive amendment,
then the “no-loss rule” applies, and the opinion of the
panel, as written by Chief Judge Posner, is absolutely cor-
rect. Second, the law, as crafted by the Treasury Depart-
ment and approved by our panel today, may indeed be
better than the one enacted by Congress.’

Nevertheless, I am unwilling to place my imprimatur
upon Executive Branch legislation that makes changes in
the statute that the Treasury Secretary believes are
needed.2 If the law is clear and unambiguous, Id follow
the law. If the law is unclear, then I’d give great defer-
ence to the interpretation of the agency involved. But, if
the law says “drive from Washington to Baltimore,” and
the regulations say, “stop overnight in Annapolis,” this
direct conflict with the controlling statute should be de-
clared invalid.

As I have said many times, I look respectfully upon the
men and women of Congress as grownups who know what
they are doing.’ I find it inappropriate to patronize them

1“It may be that the Act now created by our Court is a better
or more complete Act than the one actually passed by the Congress.
Who knows? Its deficiency is that .. . [it] was never submitted to
the people’s elected representatives and edotped by them.” Wilson
v. First Houston Inv. Corp. 566 F.2d 1235, 1243 (5th Cir. 1978)
(Hill, J., dissenting), vacated. 444 U.S. 959 (1979).

2This is a personality disorder often found in bureaucrats and
federal judges.

3 “But if another course is to be chosen, the fine men and women
who have been elected to represent the people are quite competent
to the task. The judiciary should neither assume the responsibility
nor usurp authority not delegated to it.” Roberts v. Austin, 632
F.2d 1202, 1215 (5th Cir.1980) (Hill, J., concurring specially),
cert. denied, 454 U.S. 975 (1981).

8a

by noting their imperfect work and quietly correcting it.
Moreover, I have even greater respect for Article I, Sec-
tion 1 of the United States Constitution that confers the
power to legislate upon these fine men and women. It
doesn’t confer that power upon the Treasury Department.
It doesn’t confer that power upon us, the judiciary.

Without the “no-loss rule,” the judgment of the district
court is correct. Having—not without some hesitation—
concluded that Congress did not enact the “no-loss rule,”
I would affirm the judgment of the district court.

So I dissent.*
A true Copy:
Teste:

Clerk of the United States Court of
Appeals for the Seventh Circuit

4 This is probably just another example of the ongoing tension
between the legislative, executive and judicial branches as to their
appropriate roles under the Constitution.

9a

APPENDIX B
[Filed Sep. 8, 1992]

IN THE UNITED STATES DISTRICT COURT
FOR THE CENTRAL DISTRICT OF ILLINOIS

Case Number 89-2325

ARCHER-DANIELS-MIDLAND COMPANY, éf al.,
Plaintiffs,
Vs.

UNITED STATES OF AMERICA,
Defendant.

ORDER

Archer-Daniels-Midland Company (ADM) brought this
action against the United States of America on behalf of
itself and as the common parent of an affiliated group of
corporations. ADM is seeking a refund of federal taxes
along with interest paid to the United States for the tax
years 1975 through 1978. The parties have filed cross
motions for partial summary judgment. (docket #17 and
19) The only issue involved in these motions is whether
Treas. Reg. § 1.994-1(e)(1)(i), 26 C.F.R. § 1.994-
1(e)(1)(i), which limits the use of two methods for
determining the taxable income of a domestic interna-
tional sales corporation (DISC), is valid. For the rea-
sons set forth below, the court agrees with the plaintiffs
that Treas. Reg. § 1.994-1(e)(1) (i) is invalid.

1 The remaining issue in the case concerns the taxation of insur-
ance transactions involving ADM’s two wholly-owned foreign sub-
sidiaries engaged in the insurance business.

a NE

10a

I. INTERNAL REVENUE CODE SECTION
AND TREASURY REGULATION

Congress enacted the DISC provisions, 26 U.S.C.
$§ 991-997," as a part of the Revenue Act of 1971. The
purpose of the provisions “was to provide tax incentives
for United States firms to increase their exports and to
remove the previous tax disadvantage of firms engaged in
export activities through domestic corporations instead of
through foreign subsidiaries.” Thomas International, Ltd.
v. United States, 773 F.2d 300, 301 (Fed. Cir. 1985),
cert. denied, 475 U.S. 1045 (1986); LeCroy Research
Sys., Corp. v. Commissioner, 751 F.2d 123, 124 (2d Cir.
1984). These provisions authorize the exporters to estab-
lish DISCs as separate subsidiaries to handle foreign sales
and leases. The basic function of a DISC, under section
993, “is the selling or leasing of export property which
has been created by someone else in the United States for
ultimate use outside the United States.” Gehl Co. v. Com-
missioner, 795 F.2d 1324, 1326 (7th Cir. 1986) (quoting
Bittker & Eustice, Federal Income Taxation of Corpora-
tions and Shareholders 4 17.14.2 (4th ed. 1979)). In
essence, a DISC may be only a shell corporation whose
sole function is to receive income from foreign sales by the
parent corporation. Thomas International, 773 F.2d at
301; see Dresser Indus. v. Commissioner, 911 F.2d 1128,
1131 (Sth Cir. 1990) (“Typically, a DISC is a paper
company without facilities, employees, or inventory of
its own.”).

The tax advantages of the DISC provisions stem from
the fact that a DISC is not subject to federal income
tax on its income from export sales. Durbin Paper Stock
Co. v. Commissioner, 80 T.C. 252, 254 (1983). In-
stead, approximately one-half of the DISC’s earnings is
taxed to its shareholders as constructive dividends. The
remainder of the earnings is not taxed until actually dis-

2 All statutory references in this order are to sections of the
Internal Revenue Code of 1954 (26 U.S.C.).

OO St tt~—sCS

lla

tributed to the shareholders. See Gehl, 795 F.2d at 1327;
Thomas International, 773 F.2d at 301; LeCroy, 751
F.2d at 124. However, the statute provides that the ex-
empted earnings must be used in export activities and
not diverted to production for the domestic market or
to production overseas. To fulfill the purposes of the
DISC provisions, the DISC scheme includes strict require-
ments for qualification as a DISC and provisions regulat-
ing “transactions and transfers involving the flow of the
DISC’s tax-deferred profits to related entities.” Gehl, 795
F.2d at 1326.

The DISC can participate in export transactions in two
different ways. In each type of transaction, the DISC
deals with a “related supplier” * in the sale of export prop-
erty* to a third party. In the first type of transaction,
the DISC operates as a principal in the resale of export
property that the DISC purchased from the related sup-
plier. Here the DISC earns income on the resale which
the related supplier would otherwise have earned. In
the second type of transaction, the DISC acts as a com-
mission agent facilitating the sale of export property
directly from the related supplier to the third party. The
DISC’s earnings in this transaction include commissions
which the related supplier can deduct as commission ex-
penses to reduce taxable income.

One provision that regulates the flow of the DISC’s
profits to related entities is section 994. This section sets
forth inter-company pricing rules used to determine the
DISC’s taxable income. As established in this section,
DISC taxable income is “based on a. . . ‘deemed’ trans-

3A “related supplier” is a related party as defined in 26 U.S.C.
§ 482 that engages in a transaction with the DISC under the
rules of 26 U.S.C. § 994. In this case, ADM and its affiliated cor-
porations acted as the related suppliers for their DISC, Ardanco,
Inc., a wholly-owned DISC of ADM.

4For the purposes of the DISC provisions, export property is
defined in 26 U.S.C. § 993(c).

12a

fer price for export goods provided to the DISC by its
parent or related supplier.” Dresser, 911 F.2d at 1131.
The statute includes three alternative formulas for deter-
mining the “deemed transfer price.” Jd. Section 994(a)
states:

In the case of a sale of export property to a DISC by
a [related supplier], the taxable income of such DISC
and such person shall be based upon a transfer price
which would allow such DISC to derive taxable
income attributable to such sale (regardless of the
sales price actually charged) in an amount which
does not exceed the greatest of —

(1) 4 percent of the qualified export receipts on
the sale of such property by the DISC plus 10 per-
cent of the export promotion expenses of such DISC
attributable to such receipts,

(2) 50 percent of the combined taxable income
of such DISC and [the related supplier] which is
attributable to the qualified export receipts on such
property derived as the result of a sale by the DISC
plus 10 percent of the export promotion expenses
of such DISC attributable to such receipts, or

(3) taxable income based upon the sale price ac-
tually charged (but subject to the rules provided in
section 482).

26 U.S.C. § 994(a). The three alternative inter-company
pricing methods for computing the taxable income from
the export sales are known as the 4 percent gross receipts
method, the combined taxable income method, and the
section 482 method.°

5 The government explains that this third method was the tra-
ditional arm’s-length method used to determine taxable income
and the first two methods are the special ones created to promote
exports by U.S. companies. See Government’s Memo in Support of
Summary Judgment at 8. (Government’s First Memo at 8) (docket
# 20).

13a

Although section 994(a) specifically applies only to
transactions in which the DISC acts as a principal, section
994(b) directs the Secretary to prescribe rules to apply
when the DISC acts as a commission agent.® The rules
are found in inter-company pricing rules for DISCs, 26
C.F.R. § 1.994-1(d) (1991). These rules apply the 4
percent gross receipts method (called simply the “gross
receipts method” in the regulations) and the combined
taxable income method in sections 994(a)(1) and (2) to
commissions.

The Secretary also has issued regulations concerning
the application of the three pricing methods. Treas-
ury Reg. 1.994-1(e)(1) (i) limits the situations in which
the 4 percent gross receipts method and the combined
taxable income method may be applied. The regulation
provides:

(e) Methods of applying paragraphs (c) and (d) of
this section—(1) Limitation on DISC income (“no
loss” rule)—(i) In general. Except as otherwise
provided in this subparagraph, neither the gross re-
ceipt method nor the combined taxable income
method may be applied to cause in any taxable year
a loss to the related supplier, but either method may
be applied to the extent it does not cause a loss. A
loss to a related supplier would result if the taxable
income of the DISC would exceed the combined
taxable income of the related supplier and the DISC.
If, however, there is no combined taxable income

6 Section 994(b) provides:

The Secretary shall prescribe regulations setting forth—

(1) rules which are consistent with the rules set forth in
this subsection (a) for the application of this section in the
case of commissions, rentals, and other income, and

(2) rules for the allocation of expenditures in computing
combined taxable income under subsection (a) (2) in those
cases where a DISC is seeking to establish or maintain a
market for export property.

14a

of the DISC and the related supplier (because, for
example, a combined loss is incurred), a transfer
price (or commission) will not be deemed to cause
a loss to the related supplier if it allows the DISC
to recover an amount not in excess of its costs (if

any).

26 C.F.R. § 1.994-1(e)(1)(i) (1991). Under this reg-
ulation, also called the no-loss rule, a party, such as ADM,
cannot use the 4 percent gross receipts method if the
application of that method would result in a loss for the
related supplier. ADM challenges the validity of this
regulation.

Il. FACTS

Since the parties have agreed to the facts surrounding
the transactions and have submitted a stipulation stating
the facts (docket #18), the court will review the facts
briefly. In March, 1972, ADM incorporated a wholly-
owned subsidiary, Ardanco, Inc. (Ardanco), to act as a
DISC of ADM within the meaning of Section 992(a).
Stipulation para. 10. During the tax years 1975 through
1978, Ardanco received commissions and transfer price
income from transactions with its related suppliers, ADM,
ADM Milling Company, ADM Export Company, Ross &
Rowe, Inc., and Tabor & Company. Stipulation 44 21-22.
In each of those years, transactions involving Ardanco
and its related suppliers were subject to suppliers’ agree-
ments that provided that “the transfer price paid . . . by
Ardanco ... or the commission . . . payable to Ardanco

. will be established in accordance with a formula
whick will entitle Ardanco to derive the maximum tax-
able income from such sales which may be allocated to
it under the intercompany pricing rules as set forth in
section 994 of the Internal Revenue Code.” Stipulation
21. ADM established intercompany accounts payable
and accounts receivable based upon the pricing methods
in section 994(a) and, in its tax returns, computed its
commissions and transfer prices applying the no-loss limi-
tation. Stipulation 4 22-23.

15a

ADM now argues, as it did in protests and refund
claims filed for the years 1975 through 1978, that the
no-loss rule is contrary to the 4 percent gross receipts
method in section 994(a)(1) and is invalid. Stipulation
424. Without the no-loss limitation, ADM’s taxable in-
come would decrease and Ardanco’s taxable income
would increase. ADM seeks a refund based on the calcu-
lation of its taxes under the 4 percent gross receipts
method, without the limitation of the no-loss rule.

Ill. DISCUSSION

Summary judgment is appropriate on the issue of the
validity of the no-loss regulation since no material facts
exist concerning this issue. The court’s role in determin-
ing the validity of a Treasury regulation is limited. Gehl,
795 F.2d at 1328. Ordinarily, a court should defer to
the regulation if the court concludes that “the regulation
‘implement[s] the congressional mandate in some reason-
able manner.’” United States v. Vogel Fertilizer Co., 455
U.S. 16, 24 (1982) (quoting United States v. Correll,
389 U.S. 299, 307 (1967)); Gehl, 795 F.2d at 1328
(listing citations); see American Medical Assoc. v. United
States, 887 F.2d 760, 770 (7th Cir. 1989) (“Treasury
regulations ‘must be sustained unless unreasonable and
plainly inconsistent with the revenue statutes’”). But this
general deferential standard is only the beginning of the
necessary analysis. This standard is further refined by the
source of authority under which the challenged regula-
tion was issued.” Gehl, 795 F.2d at 1328 (citations
omitted ).

The Commissioner may issue a regulation under the
general grant of authority to “prescribe all needful rules
and regulations,” section 7805(a), or under a specific
statutory grant of authority. Gehl, 795 F.2d at 1328.
A court owes less deference to a, regulation issued under
section 7805(a)’s general grant of authority, an inter-
pretative regulation, than to a regulation issued under a

l6a

specific grant of authority, .a legislative regulation. Rowan
Cos. v. United States, 452 U.S. 247, 253 (1981); Gehl,
795 F.2d at 1328. When reviewing a legislative regula-
tion, a court’s inquiry is limited to “whether the inter-
pretation or method is within the delegation of authority.”
Rowan, 452 U.S. at 253. Legislative regulations are con-
trolling “unless they are arbitrary, capricious, or mani-
festly contrary to the statute.” Dresser, 911 F.2d at 1137
(citations omitted). A court will uphold an interpreta-
tive regulation as a reasonable interpretation of the con-
gressional mandate only if it harmonizes with the stat-
ute’s language, origin, and purpose. Vogel, 455 U.S. at
25; National Muffler Dealers Ass’n v. United States, 440
U.S. 472, 477 (1979). But the court must “scrutinize a
regulation’s fidelity to the overall statutory framework and
legislative history.” Water Quality Ass’n Employees’
Benefit Corp. v. United States, 795 F.2d 1303, 1305-06
(7th Cir. 1986) (when appropriate, court may substitute
its judgment for an agency’s when the regulation is in-
terpretative). Thus, the weight that the court will ac-
cord to the regulation depends on the regulation’s source
of authority. Dresser, 911 F.2d at 1137.

A. Source of Authority

The source of the authority for Treas. Reg. § 1.994-
(e)(1)(i) is not clear. The government argues that the
no-loss rule is valid either as a legislative regulation au-
thorized by section 994(b)(1) or as an interpretative
regulation. To support its assertion that the no-loss rule
is a legislative regulation, the government explains that
the three inter-company pricing methods in section 994(a)
literally apply only to a DISC operating on a buy-sell
basis. When a DISC, like Ardanco, also acts as a
commission agent, it must look to the regulations prom-
ulgated under section 994(b)(1) to obtain the DISC
tax benefits. Treasury Reg. § 1.994-1(d)(2) allows com-
mission DISCs to use the 4 percent gross receipt method.

17a

The challenged “no-loss” rule is located in the next
subparagraph (e) of the regulation, which sets forth
the “methods of applying paragraphs (c) and (d)
of this section.” Accordingly, it is apparent that the
“no-loss” rule is part of an integral set of regula-
tory provisions authorized by I.R.C. Section 994(b)
(1) for establishing the parameters of the intercom-
pany pricing methods for a commission DISC situa-
tion.

Government’s Second Memo at 6. (docket #26)

ADM argues that the regulation is interpretative be-
cause neither section 994 nor any other DISC provision
in the code gives the Treasury Department the regulatory
authority to limit the 4 percent method. Specifically,
ADM asserts that the only statutory grant of authority
relating to the inter-company pricing rules is found in
section 994(b)(1) and (2). The grant of authority in
section 994(b)(1) does not encompass the authority to
promulgate the no-loss rule, ADM contends, because this
section provides only for the extension of the three pric-
ing methods in section 994(a) to DISC commission trans-
actions. Section 994(b)(1) directs the Secretary to issue
regulations that set forth “rules which are consistent with
the rules set forth in subsection (a) for the application
of this section in the case of commissions, rentals, and
other income.” The inclusion of the words “consistent
with” indicates that section 994(b)(1) does not author-
ize the Secretary to promulgate regulations, such as the
no-loss rule, which limit the inter-company pricing meth-
ods. In addition, the no-loss rule applies to commission
DISCs and to DISCs acting as the principal in a transac-
tion. The grant of authority in section 994(b)(2) is also
irrelevant here, according to ADM, because it deals only
with the combined taxable income method. ADM also
points to the Treasury Decision issuing the rules that states
the decision is issued under the authority of section 7805.
T.D. 7364, 1975-2 C.B. 315, 328.

18a

Although no court has determined whether the no-loss
rule is a legislative or interpretative regulation, several
courts have discussed section 994(b)(1)’s grant of au-
thority in regulation to other DISC regulations. In Gehl,
the Seventh Circuit discussed whether section 994(b)(1)
authorized the Secretary to promulgate Treas. Reg. § 1.993-
2(d)(2). The Court quoted the Committee Reports ex-
plaining the grant of authority in section 994(b) (1):

[T]he Secretary of the Treasury may prescribe by
regulations intercompany pricing rules, consistent
with those provided by the bill, in the case of export
transactions where the DISC does not take title to
the property, but instead, acts as a commission agent
for the sale, or is a lessee of the property which it
then subleases to its customers.

Gehl, 795 F.2d at 1329 (quoting S. Rep. No. 437,
92d Cong., Ist Sess. 108 (1971), reprinted in 1971
U.S.C.C.A.N. 1918, 2014; H.R. Rep. No. 533, 92d Cong.,
Ist Sess. 75 (1971), reprinted in 1971 U.S.C.C.A.N.
1825, 1888).* Another court explained the grant of au-
thority in section 994(b)(1) as “expressly delegat[ing] to
the Commissioner the authority to issue regulations re-
garding the amount of commissions to be charged in
transactions between related persons.” CWT Farms, Inc.
v. Commissioner, 79 T.C. 1054, 1066 (1982), aff'd, 755
F.2d 790 (11th Cir. 1985), cert. denied, 477 U.S. 903
(1986).

In Dresser, the Fifth Circuit analyzed the source of
authority of Treas. Reg. § 1.994-1(c)(6)(v). Just as in
this case, the Treasury Decision promulgating the regula-
tion at issue in Dresser stated that the regulation was is-

7 Because the Gehl court agreed with the Commissioner that the
source of the regulation’s authority did not affect the outcome of
the analysis in that case, the court assumed, without deciding,
that the challenged regulation was issued under the general grant
of authority in section 7805(a) and applied the less deferential
standard. 795 F.2d at 1329-30.

CS ae a ek a eee. s

ee eee ee

19a

sued under the general grant of authority in section 7805
(a). However, the court stated that it was “not bound
by mere nomenclature used by the issuing agency.” 911
F.2d at 1138. Instead, the court found that the proper
approach to determining the regulation’s source of au-
thority was to examine the statutory language and the
regulation itself. Jd. at 1138-1139. After analyzing the
language and the legislative history of section 994(b),
the court concluded that “Congress intended the tax treat-
ment of commission DISCs to be consistent with the
treatment of buy-sell DISCs. Congress specifically author-
ized the Secretary to make rules ensuring that consist-
ency.” Jd. at 1139. In finding that Treas. Reg. § 1.994-1
(c)(6)(v) is a legislative regulation, the court relied on
two facts: (1) the regulation “is directed exclusively to
the calculation of deemed intercompany transfer prices
in the case of commission DISCs,” and, thus, falls within
the rulemaking authority granted in section 994(b), and
(2) the regulatory provisions which “fall squarely within
the specific grant of rulemaking authority set out in code
section 994(b),” section 1.994-1(d), incorporate section
1.994-1(c)(6) by reference. Jd. at 1140.*

Following the analysis set forth in Dresser, the court
concludes that Treas. Reg. § 1.994-1(e)(1)(i) is an in-
terpretative regulation. Section 994(b) authorizes the
Secretary to prescfibe regulations for determining the
deemed transfer price in transactions involving commis-
sion DISCs and to ensure consistency in the treatment
of commission and buy-sell DISCs. The no-loss rule ex-
ceeds this grant of authority. Although the no-loss rule
directly relates to the calculation of the deemed transfer

8 In LeCroy, the court found that Treas. Reg. § 1.994-1(e) (8)
is a legislative regulation since it furthers the same goal as the
rules governing payments in a section 994 transaction and prevents
the circumvention of other statutory limitations on DISCs. 751
F.2d at 125-26. But see Thomas International, 773 F.2d at 303.
Like the regulation at issue in Dresser, the challenged regulation
in LeCroy related exclusively to commission DISCs.

20a

price of export goods under section 994, it applies a
limitation to the calculation of the transfer price in
transactions involving both commission DISCs and buy-
sell DISCs. In addition, the government does not argue
that the no-loss rule furthers the same goal as the rules
in section 994 and, thus, must come under the same grant
of authority. See Gehl, 795 F.2d at 1329 (discussing
LeCroy).

B. The Terms that the Regulation Interprets

After determining the source of authority of a chal-
lenged regulation, the general deferential standard used in
assessing the validity of a regulation is refined further by
focusing on the term that the regulation interprets. Gehl,
795 F.2d at 1330. “Where the term that the regulation
purports to interpret has already been specifically defined
by Congress, the Commissioner’s authority to promulgate
the regulation is relatively more circumscribed than if
the term used is a general one that was not further de-
fined by Congress.” Id. (citing Vogel, 455 U.S. at 24);
Thomas International, 773 F.2d at 303. In other words,
if the statutory language is unambiguous, the Commis-
sioner has less freedom to define and interpret it. A reg-
ulation that contradicts the unambiguous language of the
statute or adds a requirement to the statute without a
valid reason cannot stand. CWT Farms, 79 T.C. at 1062
(citations omitted); Arrow Fastener Co. v. Commissioner,
76 T.C. 423, 430 (1981). “Finally, although a regula-
tion does not clearly contradict or limit the provisions of
the statute it purports to interpret, it is nonetheless in-
valid if it is inconsistent with the statute’s origin and
purpose.” CWT Farms, 79 T.C. a 1062 (citing Vogel,
455 US. at 26).

ADM maintains that section 994(a)(1) is unambig-
uous. The Congressional language in section 994(a),
ADM contends, is clear and precise in its creation of a
mathematical formula for establishing the taxable income

Ww aegh handel Sheet i ieee eee

Ley |

21a

of a DISC. ADM rejects any contention that section 994
is merely a general framework and insists that, if Con-
gress had intended to enable the Treasury Department to
lower the 4 percent formula in certain situations, Con-
gress would have given the Treasury Department such
explicit regulatory power.

The government, on the other hand, argues that section
994(a) does not state a clear mathematical rule. And,
according to the government, the Secretary followed the
express intent of the Congressional Committees by prom-
ulgating the no-loss rule. The government relies on reports
of the House Ways and Means Committee, the Senate
Finance Committee, and the Joint Committee on Internal
Revenue Taxation which include this statement concern-
ing section 994(a)(1) and (2):

Under the first of the two new rules, a DISC may
earn that portion of the combined taxable income
arising on the sale by a DISC of export property
purchased from a related person which does not ex-
ceed 4 percent of the qualified export receipts from
the sale, plus 10 percent of the DISC’s export promo-
tion expenses attributable to the sale. Income may
not, however, be allocated to the DISC under this
(or the second) rule to the extent it would result
in the related person who sold the products to the
DISC incurring a loss on the sale.

H.R. Rep. No. 533, 92d Cong., Ist Sess. 74 (1971),
reprinted in 1971 U.S.C.C.A.N. 1825, 1887; S. Rep. No.
437, 92d Cong., Ist Sess. 107-108 (1971), reprinted in
1971 U.S.C.C.A.N. 1918, 2013; Joint Committee on Tax-
ation, General Explanation of the Revenue Act of 1971,
at 102 (1972).

To support the no-loss rule as a reasonable interpreta-
tion of section 994(a), the government disputes ADM’s
characterization of section 994(a) as a mathematical for-
mula. To the government, the language of the statute
clearly demonstrates that 994(a) is not a mathematical

22a

formula and is appropriate for regulatory interpretation.
Specifically, the fact that the language in section 994(a)
allows the DISC to derive taxable income which “does
not exceed the greatest of” the three pricing methods in-
dicates that Congress intended to create a general frame-
work which the Secretary would interpret. This language
does not mandate the use of a specific 4 percent mathe-
matical formula at all times; rather, any amount less than
the amount calculated under the 4 percent method “does
not exceed” the statutory limitation and can be used.

The court finds that the language of section 994(a)
is unambiguous. Unlike statutory sections which con-
tain terms that require further definition, such as “ac-
counts receivable,” section 994(a) has been specifically
defined by Congress. The government’s reliance on the
phrase “an amount which does not exceed the greatest
of” is misplaced. The plain meaning of this phrase when
followed by three alternative methods is that the tax-
payer can choose one of the three methods, including
one that allows the DISC to derive less taxable income
than another method. If the government’s interpretation
of this phrase were correct, the Secretary could promul-
gate regulations forcing the DISC to receive any amount
less than the amount calculated under the three methods.
Such a result would contradict the DISC provisions’ pur-
pose of encouraging exports. The Secretary cannot add
a restriction or limitation to an unambiguous statutory

provision. Durbin Paper, 80 T.C. at 257; Arrow Fastener,
76 T.C. at 431.

Moreover, because the court does not find doubt con-
cerning the meaning of the terms in section 994(a), it
will not look to the legislative history to discover a limi-
tation that Congress did not include in the statute. See
In re Sinclair, 870 F.2d 1340, 1344 (7th Cir. 1989)
(“Legislative History helps us learn what Congress meant
by what it said, but it is not a source of legal rules com-
peting with those found in the U.S. Code.”). Although
the Committee reports indicate that the provisions do

q ——orrrsr

23a

not allow the related supplier to take a loss, the statute,
as enacted, does not include this limitation. In addition,
the government has not persuaded the court that the no-
loss rule is in harmony with the statute’s origin and pur-
pose. Unlike the regulation at issue in Gehl or Thomas
International, the government has not argued that this
regulation is necessary to prevent circumvention of another
statutory section in the DISC scheme. See Gehl, 795
F.2d at 1330; Thomas International, 773 F.2d at 304.
Finally, the government cannot argue that the goal of
encouraging exports through the use of domestic subsidi-
aries is furthered by this provision.

The government also asserts that sections 994(a)(1)
and (2) only address the allocation of taxable income
between the DISC and the related supplier, whereas the
no-loss rule deals with the export transactions that re-
sult in less than zero taxable income for the related
supplier.

Specifically, the no-loss rule addresses the related
but distinct issue of whether the related supplier may
claim a deduction for a Joss from the sale of export
property which results in taxable income of less that
$0 to the related supplier. The no-loss rule does
not “modify” or “amend” the statutory provision,
which clearly does not address the issue of the allow-
ance of loss deduction.

Government’s First Memo at 14. (docket #20) More-
over, the no-loss rule, according to the government, im-
plements Congressional intent concerning the related sup-
plier’s ability to take a loss deduction. See Government's
Second Memo at 11-15 for further argument concerning
allocation of income under section 994(a). (docket #26)
With this argument, the government appears to be trying
to justify the no-loss rule even if section 994(a) is un-
ambiguous.

ADM asserts that the government’s attempt to char-
acterize the no-loss rule as dealing with the allowance

24a

of deductions misreads section 994(a). Using ADM’s
reasoning, section 994(a) does not allocate taxable in-
come; instead, section 994(a) provides the basis for de-
termining taxable income or, in other words, establishes
the taxable income of the related supplier and the DISC
from the export transaction. ADM claims that the gov-
ernment cannot and does not dispute the fact that the
related supplier can have negative taxable income under
the 4 percent method. If the taxable income is a negative
amount, the unambiguous 4 percent method does not
allow the Secretary to come in and change the result.
In addition, ADM contends that the Internal Revenue
Code sections dealing with deductions cannot support
the no-loss rule. See Plaintiff's Second Memo at 8-9.
(docket #23)

Cases discussing the inter-company pricing rules in
section 994(a) refer to them as allocating profits, Gehl,
795 F.2d at 1327, as establishing a “deemed” transfer
price used to calculate income, Dresser, 911 F.2d at
1131, and as allocating income. Even assuming that the
purpose of the three methods in section 994(a) is to
allocate income, the government’s argument does not sup-
port the addition of a restriction to an unambiguous
statutory section.

IT IS THEREFORE ORDERED that the plaintiffs’
motion for partial summary judgment is GRANTED; the

defendant’s motion for partial summary judgment is
DENIED.

IT IS FURTHER ORDERED that the court will hold
a status hearing in this case by telephone conference call
on October 20, 1992, at 10:30 a.m.

ENTER THIS 8th day of September, 1992.

/s/ Harold A. Baker
HAROLD A. BAKER
United States District Judge

25a
APPENDIX C

UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
Chicago, Illinois 60604

November 2, 1994

Before Hon. Richard A. Posner, Chief Circuit Judge
Hon. James C. Hill, Circuit Judge*
Hon. Kenneth F. Ripple, Circuit Judge

No. 93-3939

ARCHER-DANIELS-MIDLAND COMPANY, on its own behalf
and as common parent of an affiliated group of cor-
porations, FLEISCHMANN-KURTH MALTING COMPANY,
INCORPORATED, and COEVAL, INCORPORATED,

Plaintiffs-A ppellees,

V.

UNITED STATES OF AMERICA,
Defendant-A ppellant.

Appeal from the United States District Court
for the Central District of Illinois, Danville Division
No. 89 C 2325—Harold A. Baker, Judge

* Hon. James C. Hill, of the Eleventh Circuit, sitting by desig-
nation.

26a
ORDER

On October 13, 1994, plaintiffs-appellees filed a peti-
tion for rehearing with a suggestion for rehearing en banc.
All the judges on the original panel have voted to deny
the petition, and none of the active judges has requested
a vote on the suggestion for rehearing en banc. The pe-
tition is therefore DENIED.

27a

APPENDIX D
[Filed Oct. 12, 1993]

UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF ILLINOIS

Case Number: 89-2325

ARCHER-DANIELS-MIDLAND COMPANY, (on its own behalf
and as common parent of an affiliated group of cor-
porations), FLEISCHMANN-KURTH MALTING Co., INC.,
and CoEVAL, INC.

vs.

UNITED STATES OF AMERICA

JUDGMENT IN A CIVIL CASE

| [XX] Decision by Court. This action came to trial or
hearing before the Court. The issues have been
tried or heard and a decision has been rendered.

| IT IS ORDERED AND ADJUDGED that the claims
| for relief designated as insurance matters set forth in the
Complaint in this matter in paragraphs 20 through 34
and 70 through 72, and, insofar as they are based on
the grounds stated in paragraphs 20 through 34, the
claims set forth in paragraphs 43 through 64, 74 through
84, 92 through 95, and 102 through 120, be dismissed with
prejudice pursuant to the stipulation of the parties filed
July 7, 1993, each party to bear its own costs, including
any possible attorneys fees or other expenses of litiga-
tion, with respect to such claims.

| IT IS FURTHER ORDERED that the plaintiffs shall
recover from the defendant United States of America pur-
suant to claims for relief, relating to the plaintiffs’ do-

28a

mestic international sales corporation, set forth in the
Complaint in this matter in paragraphs 35 through 42,
and, insofar as they are based on the grounds stated in
paragraphs 35 through 42, the claims set forth in para-
graphs 43 through 64, 73 through 84, 92 through 95, and
101 through 120, the sums of $2,116,171 in taxes and
$578,108 in assessed interest for 1974, $4,859,697 in
taxes and $2,286,572 in assessed interest for 1975,
$9,547 and $751 in taxes attributable to carryback tax
credits with respect to the separate returns for 1975 of
Fleischmann-Kurth Malting Co., Inc. and Coeval, Inc.,
respectively, $4,139,230 in taxes and $2,048,820 in as-
sessed interest for 1976, $2,666,746 in taxes and
$157,506 in assessed interest for 1977, $4,116,484 in
taxes and $2,858,285 in assessed interest for 1978 (to-
talling refunds of $17,908,896 in taxes and $7,929,291
in assessed interest), and statutory interest on all such
amounts as provided by 26 U.S.C. 6621, each party to
bear its own costs, including any possible attorneys fees
or other expenses of litigation, with respect to such
claims.
JOHN M. WATERS
Clerk

/s/ Mary C. Burnstein
(By) Deputy Clerk

Date October 12, 1993

— T

ah era fh, Meet aa a eee, tee fee

FEEL AE og RMSE MET NARD

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386012_1178%3A1. Public record. Not legal advice.