Anderson, Clayton & Co. v. U.S.

• Decision Date: 11 November 1977
• Docket Number: No. 75-2573,75-2573
• Citation: 562 F.2d 972
• Parties: 77-2 USTC P 9727 ANDERSON, CLAYTON & CO., Plaintiff-Appellee-Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant-Cross-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 972

562 F.2d 972

77-2 USTC P 9727

ANDERSON, CLAYTON & CO., Plaintiff-Appellee-Cross-Appellant, v. UNITED STATES of America, Defendant-Appellant-Cross-Appellee.

No. 75-2573.

United States Court of Appeals Fifth Circuit.

Nov. 11, 1977.

Rehearing and Rehearing En Banc Denied Dec. 20, 1977.

Edward B. McDonough, Jr., U. S. Atty., Robert Darden, Asst. U. S. Atty., Houston, Tex., Scott P. Crampton, Asst. Atty. Gen., Tax Div., U. S. Dept. of Justice, Gary R. Allen, David English Carmack, Gilbert E. Andrews, Jr., Acting Chief, Appellate Sec., Dept. of Justice, Washington, D. C., for defendant-appellant-cross-appellee.

C. W. Wellen, Steven C. Salch, Houston, Tex., for plaintiff-appellee-cross-appellant.

Appeals from the United States District Court for the Southern District of Texas.

Before TUTTLE, GOLDBERG and CLARK, Circuit Judges.

GOLDBERG, Circuit Judge:

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 distribution 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 I.R.C. § 904(a)(1). ¹ The second matter concerns promissory 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 governing the "sourcing" of dividends that was promulgated after the district court's decision in this case. ² 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 deduction for the wartime decline in exchange value of foreign currency holdings that had not been converted into dollars. ³ We hold that the government was not collaterally estopped and affirm the district court's judgment for the government on this issue.

SOURCE OF A MINIMUM DISTRIBUTION OF SUBPART F INCOME

I.

Taxpayer is a large, widely-held corporation engaged along with its subsidiaries 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, ⁴ taxpayer, as authorized by § 963 of the Code, elected to report as income a minimum distribution 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 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 transactions.

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 distribution as income sourced in Brazil, and $15,517.49 of the minimum 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 limitation 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 comprising it were earned. The government asserted that the distribution 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 taxpayer or that proposed by the government more faithfully carried out Congress's purpose regarding the interplay between 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.

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

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 government'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. Commissioner of Internal Revenue, 488 F.2d 728 (5th Cir. 1974); K. Davis, Administrative Law § 5.03 (3d ed. 1972). ⁶

Before addressing the questions whether Treas.Reg. § 1.902-3(d)(1) is valid and whether it is retroactively applicable to the case at bar, we need to place the regulation in the context of the complex statutory scheme regarding the tax treatment of subpart F income. ⁷ After attempting 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.

II.

Prior to 1962, the foreign source income of a foreign corporation was not subject to United States income tax until distributed as dividends to its United States shareholders. ⁸ 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 corporation 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 subsidiary 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 Congress in 1961, President Kennedy questioned the wisdom of such favorable tax treatment: "The undesirability of continuing deferral is underscored where deferral has served as a shelter for tax escape through the unjustifiable use of tax havens such as Switzerland." Id.

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 legislation may be summarized as follows: if the subpart F income of a controlled foreign corporation ⁹ exceeds certain limits, a United States shareholder ¹⁰ 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. ¹¹

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 distributions. The purpose of this provision is to forego any tax on the domestic shareholders with respect to undistributed income of controlled foreign corporations in cases when the combined foreign and United States tax (to the extent...