Preece v. Comm'r of Internal Revenue, Docket No. 17010-89.

Citation95 T.C. 594,95 T.C. No. 41
Decision Date05 December 1990
Docket NumberDocket No. 17010-89.
PartiesDEBRA F. PREECE AND DAVID K. PREECE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

Ps were present in the Commonwealth of the Northern Mariana Islands (CNMI) in excess of 183 days in 1985. Ps move for summary judgment that they were residents of CNMI under the substantial presence test of I.R.C. section 7701(b)(3)(A). In the alternative, Ps move for summary judgment that they were residents of CNMI under a facts and circumstances test as provided in section 1.871-2, Income Tax Regs. HELD, the issue of whether the substantial presence test or a facts and circumstances test provides the standard for determining whether Ps were residents of CNMI in 1985 is appropriate for summary judgment. HELD FURTHER, Ps' residency in CNMI is to be determined pursuant to a facts and circumstances test. HELD FURTHER, the issue of whether Ps were residents of CNMI under a facts and circumstances test is not appropriate for summary adjudication. John A. Townsend, for the petitioners.

James M. Kamman and Christopher D. Hatfield, for the respondent.

OPINION

NIMS, CHIEF JUDGE:

This matter is before the Court on petitioners' motion for summary judgment pursuant to Rule 121. (Unless otherwise indicated, section references are to the Internal Revenue Code as amended and in effect for the year at issue. Rule references are to the Tax Court Rules of Practice and Procedure.)

This case involves the question of whether the so-called mirror code of the Commonwealth of the Northern Mariana Islands (CNMI) requires a holding that petitioners, United States citizens, were residents of CNMI in 1985 and therefore not subject to United States income tax. Central to this question is the resolution of whether the substantial presence test of section 7701(b)(3)(A) provides the standard for determining the residency of United States citizens for purposes of section 935, or whether the facts and circumstances test of sections 1.871-2 through 1.871-5, Income Tax Regs., continues to be applicable.

FACTUAL BACKGROUND

The following statement of facts is based on an affidavit of Debra F. Preece attached to petitioners' motion for summary judgment. The facts so stated are solely for the purpose of deciding petitioners' motion for summary judgment and for no other purpose.

At all relevant times, Debra and David Preece (petitioners) were husband and wife. At the time the petition was filed, petitioners resided in Spring, Texas. Debra Preece owned approximately nine percent of the stock of Diet Center, Inc. (DCI). DCI was a family- owned corporation, organized by her parents in the early 1970s. In January, 1985, petitioners attended a family meeting and were informed that DCI might be sold. Petitioners were further advised that establishing residency in CNMI would substantially reduce the income taxes arising from the sale of the DCI stock.

In March, 1985, petitioners moved to Saipan, CNMI. Petitioners state that the principal motivating factor for the move to CNMI was the expected tax savings associated with the CNMI 95-percent territorial income tax rebate for CNMI source income. After arriving in CNMI, petitioners rented an apartment, enrolled their children in school, purchased a car, opened bank accounts, registered to vote, obtained driver licenses, and involved themselves in a local church.

On April 1, 1985, petitioners sold the DCI stock by executing a stock transfer and delivering the stock certificate to an attorney in CNMI. Petitioners realized proceeds from the sale of the stock in the amount of $5,258,840.

On April 14, 1986, petitioners filed a joint income tax return for 1985 with the Division of Revenue and Taxation in CNMI, reporting the proceeds from the sale of the stock as CNMI source income. Petitioners remained in CNMI until July, 1986, at which time they returned to the United States.

On April 11, 1989, respondent issued a statutory notice of deficiency to petitioners determining that petitioners improperly failed to file Federal individual income tax returns for 1985. On July 11, 1989, petitioners filed a timely petition challenging respondent's determination. Petitioners allege in their petition that they were residents of CNMI and, pursuant to section 935(b), properly filed their income tax returns with CNMI in the year at issue. Petitioners further allege that they were relieved of the liability to file Federal income tax returns by virtue of section 935(c)(3).

SUMMARY JUDGMENT

On June 1, 1990, petitioners filed a motion for summary judgment with a supporting memorandum and affidavits. On July 13, 1990, respondent filed a notice of objection with a memorandum and affidavit in support of the notice of objection. Petitioners filed a reply memorandum on July 23, 1990. A hearing was held on July 25, 1990, to consider petitioners' motion for summary judgment, which the Court then took under advertisement.

Petitioners' primary contention is that the substantial presence test of section 7701(b)(3)(A) (the substantial presence test), read in the context of CNMI's mirror code, provides the standard for determining the residency of United States citizens for purposes of section 935. Petitioners contend that this Court must find as a matter of law that they were residents of CNMI for purposes of section 935 because they were present in CNMI in excess of 183 days in the year at issue. In the alternative, petitioners claim that the undisputed facts support a finding that they were residents of CNMI under a facts and circumstances test as described in sections 1.871-2 through 1.871-5, Income Tax Regs. (the facts and circumstances test).

It is respondent's position that a determination of residency of United States citizens for purposes of section 935 is to be made under the facts and circumstances test, not the substantial presence test. Respondent further argues that summary judgment is inappropriate with respect to the facts and circumstances test because material facts are in dispute.

Under Rule 121(b), summary judgment is appropriate ‘if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law.‘ Zaentz v. Commissioner, 90 T.C. 753, 754 (1988); Naftel v. Commissioner, 85 T.C. 527, 529 (1985). The moving party bears the burden of proving that no genuine issue exists as to any material fact and that he is entitled to judgment on the substantive issues as a matter of law. Espinoza v. Commissioner, 78 T.C. 412, 416 (1982). In deciding whether to grant summary judgment, we view the factual material and inferences drawn therefrom in the light most favorable to the party opposing the motion. Naftel v. Commissioner, 85 T.C. at 529.

The parties' disagreement over the proper test for determining petitioners' residency for purposes of section 935 is ripe for partial summary adjudication. Rule 121(b). Respondent admits for purposes of the pending motion that petitioners were present in CNMI for 183 days during 1985. Petitioners in turn admit that they were present in the United States for 365 days in 1983, 365 days in 1984, and in excess of 31 days in 1985.

DISCUSSION

We will review CNMI's system of taxation, as well as sections 935 and 7701(b)(3)(A), before addressing the arguments of the parties.

CNMI

Prior to 1975, the Northern Mariana Islands were a part of the United Nations Trust Territory of the Pacific Islands, administered by the United States. See Trusteeship Agreement for the Former Japanese Mandated Islands, July 18, 1947, United Nations-United States, 61 Stat. 3301, T.I.A.S. No. 1665; H.J. Res. 233, 61 Stat. 397 (1947). In February, 1975, the United States and the people of the Northern Mariana Islands entered into a ‘Covenant to Establish a Commonwealth of the Northern Mariana Islands in Political Union with the United States of America‘ (the Covenant). The Covenant was ratified by a plebiscite in the Northern Mariana Islands on June 17, 1975, and formally approved by Congress on March 24, 1976. See Pub. L. 94-241, 90 Stat. 263 (1976), reprinted in 48 U.S.C. section 1681 note, at 209 (1988).

In January, 1978, section 601(a) of the Covenant was given effect. Proc. No. 4534, 42 Fed. Reg. 56,593 (1977). Section 601(a) provided that the income tax laws of the United States would be applied in the Northern Mariana Islands as a local territorial income tax. The Covenant provided that the taxation system would function in the same manner as the system adopted in Guam.

Section 31 of the Organic Act of Guam, Pub. L. 81-630, 64 Stat. 392 (1950), as amended, Pub. L. 85-688, 72 Stat. 681 (1958), provided that the Internal Revenue Code would be applied as a local territorial income tax in Guam. However, the tax laws would be applied in a mirror context by substituting the word ‘Guam‘ for ‘United States‘ where appropriate. See 48 U.S.C. section 1421i(e) (1988). A jurisdiction employing a mirror code generally treats the United States in the same manner as the United States treats the implementing jurisdiction. Flores v. Government of Guam, 444 F.2d 284, 287 (9th Cir. 1971).

Consistent with the adoption of a mirror revenue code in CNMI, section 601(c) of the Covenant provided that references in the Internal Revenue Code to Guam were deemed to refer to CNMI where not otherwise distinctly expressed or manifestly incompatible with the intent thereof or of the Covenant. Full implementation of the CNMI mirror revenue code was achieved effective January 1, 1985. See section 3 of Pub. L. 98-213, 97 Stat. 1459 (1983). (For purposes of clarity, the word ‘CNMI‘ will be inserted next to the word ‘Guam‘ throughout the remainder of this opinion where appropriate.)

SECTION 935

Prior to 1972, provisions of the Internal Revenue Code required taxpayers...

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