Ameican Air Liquide, Inc. & Subsidiaries v. Comm'r of Internal Revenue, 20381–98.

• Decision Date: 16 January 2001
• Docket Number: No. 20381–98.,20381–98.
• Citation: 58 U.S.P.Q.2d 1252,116 T.C. No. 3,116 T.C. 23
• Parties: AMERICAN AIR LIQUIDE, INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

116 T.C. 23

116 T.C. No. 3

58 U.S.P.Q.2d 1252

AMERICAN AIR LIQUIDE, INC. AND SUBSIDIARIES, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 20381–98.

United States Tax Court.

Jan. 16, 2001.

Taxpayer, parent of consolidated group, petitioned for redetermination of deficiencies arising from IRS' determination that its royalty income was passive income for foreign tax credit calculation. On cross-motions for summary judgment, the Tax Court, Laro, J., held that royalty income from license agreements for intellectual property was passive income, rather than general limitation income.

Motion of IRS granted.

Judgment affirmed, 45 Fed. Appx. 721. P is the parent of a consolidated group that includes L. P's ultimate parent is L'Air, a French corporation. L'Air pays royalties to P and L under license agreements for intellectual property owned by P and L and used by L'Air outside the United States.P treated the royalty income as sec. 904(d)(1)(I), I.R.C., general limitation income, relying on the “reserved” paragraph in sec. 1.904–5(i)(3), Income Tax Regs.; Article 24(3) of the U.S.-France Treaty, the capital nondiscrimination provision; and written statements of Treasury officials.R determined the royalty income is sec. 904(d)(1)(A), I.R.C., passive income for the purpose of calculating P's foreign tax credit.Held: The royalty income is passive income for the purpose of calculating P's foreign tax credit. Neither alone nor in combination did the “reserved” paragraph in sec. 1.904–5(i)(3), Income Tax Regs., Article 24(3) of the U.S.-France Treaty, or written statements of Treasury officials constitute an exception to sec. 904(d) entitling P to characterize the royalty income as general limitation income.E.A. Dominianni and Edmund S. Cohen, for petitioner.

Robert E. Cudlip, Steven R. Winningham, and Lydia A. Branche, for respondent.

OPINION

LARO, J.

Respondent determined deficiencies in petitioner's Federal income taxes of $320,351, $1,083,746, and $942,456 for 1989, 1990, and 1991,¹ respectively.

This matter is before the Court on cross motions for judgment on the pleadings under Rule 120(a).² In support of its motion, petitioner attached exhibits to its response. These exhibits require us to consider matters outside the pleadings, and as a consequence we have recharacterized the motions as cross-motions for summary judgment under Rule 121. See Rule 120(b).

We must decide whether royalties received by petitioner, a domestic corporation, from its foreign parent should be classified as section 904(d)(1)(A) passive income or as section 904(d)(1)(I) general limitation income for purposes of determining petitioner's foreign tax credit. We hold that they are section 904(d)(1)(A) passive income.

Background

Petitioner's principal place of business was located in Walnut Creek, California, when the petition was filed. American Air Liquide, Inc. (AAL), is the common parent of a group of corporations that filed a consolidated returns in the years in issue. Liquid Air Corp. (LAC) is a member of AAL's affiliated group.

L'Air Liquide, S.A. (L'Air), is a French corporation that is the ultimate parent of petitioner. L'Air produces, sells, and distributes industrial gases, related equipment and services, and welding products throughout the world through its own operations in France and through its French and non-French subsidiaries.

In 1986, AAL acquired the LAC research facilities and rights to all technical information developed, or being developed, by LAC. Under various license agreements among AAL, LAC, and L'Air, AAL and LAC received royalties of $4,775,000, $5 million, and $4,800,000 from L'Air in 1989, 1990, and 1991, respectively. The royalties were paid by L'Air for nonexclusive, irrevocable, and perpetual licenses to exploit, outside the United States, certain technical information developed (or to be developed) at LAC's research facility and certain improvements made (or to be made) to certain patent rights licensed to LAC by L'Air. On its tax returns for the years in issue, petitioner characterized the royalties received from L'Air as section 904(d)(1)(I) general limitation income for foreign tax credit purposes. On examination, respondent recharacterized the royalties as section 904(d)(1)(A) passive income. The deficiencies are a result of this recharacterization.

Discussion

A. Whether Summary Judgment Is Appropriate

Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. See Northern Ind. Pub. Serv. Co. & Subs. v. Commissioner, 101 T.C. 294, 295, 1993 WL 393062 (1993); Florida Peach Corp. v. Commissioner, 90 T.C. 678, 681, 1988 WL 31439 (1988); Shiosaki v. Commissioner, 61 T.C. 861, 862, 1974 WL 2549 (1974). Summary judgment is appropriate where there is no genuine issue as to any material fact and a decision may be rendered as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520, 1992 WL 88529 (1992), affd. 17 F.3d 965 (7th Cir.1994); Jacklin v. Commissioner, 79 T.C. 340, 344, 1982 WL 11139 (1982). In deciding whether to grant summary judgment, the Court must consider the factual materials and inferences drawn from them in the light most favorable to the nonmoving party. See Bond v. Commissioner, 100 T.C. 32, 36, 1993 WL 7551 (1993); Naftel v. Commissioner, 85 T.C. 527, 529, 1985 WL 15396 (1985).

The parties agree that for the purpose of deciding these cross-motions there are no genuine issues of material fact and that the Court may decide the issue as a matter of law. Hence, this case is ripe for summary judgment.

B. Characterization of Royalty Income

The determination of the proper characterization of the royalty income requires an analysis of the following provisions: (1) Section 904, (2) section 1.904–5, Income Tax Regs., and (3) Article 24(3) of the Convention With Respect to Taxes on Income and Property, July 28, 1967, U.S.-Fr., T.I.A.S. 6518, as amended by Supplementary Protocols, Oct. 12, 1970, T.I.A.S. 7270; Nov. 24, 1978, T.I.A.S. 9500; Jan. 17, 1984, T.I.A.S. 11096; and June 16, 1988, T.I.A.S. 11967 (U.S.-France Treaty).

1. Statutory Background

Pursuant to section 904(a), the amount of foreign tax credit allowable under section 901 may not exceed the same proportion of the tax against which such credit is claimed which the taxpayer's taxable income from sources without the United States bears to its entire taxable income for the same taxable year. See sec. 904(a). Under section 904, the allowable foreign tax credit is computed separately for each of the categories or baskets of income listed in subparagraphs (A) through (I) of section 904(d)(1).³ We concern ourselves with two of these baskets. The first, subparagraph (I), is referred to as general limitation income. The other is subparagraph (A), referred to as passive income. In pertinent part, section 904(d)(2)(A) defines passive income as “any income received or accrued by any person which is of a kind which would be foreign personal holding company income (as defined in section 954(c)).” Subparagraph (A) of section 954(c)(1) defines “foreign personal holding company income” to include “Dividends, interest, royalties, rents, and annuities.”

Respondent focuses on the facts that section 904(a)(1) places passive income into a passive basket and that “royalties” are specifically referred to in section 954(c)(1) as a type of passive income. Petitioner expands on this focus by reference to section 904(d)(3)(C) and section 1.904–5, Income Tax Regs., which together apply a look-through rule in the case of controlled foreign corporations and other entities. Section 904(d)(3)(C) provides:

Any interest, rent, or royalty which is received or accrued from a controlled foreign corporation in which the taxpayer is a United States shareholder shall be treated as income in a separate category to the extent it is allocable (under regulations prescribed by the Secretary) to income of the controlled foreign corporation.

Section 1.904–5(b), Income Tax Regs., provides:

In general. Except as otherwise provided in section 904(d)(3) and this section, dividends, interest, rents, and royalties received or accrued by a taxpayer from a controlled foreign corporation in which the taxpayer is a United States shareholder shall be treated as general limitation income. Section 1.904–5(i)(3), Income Tax Regs., is also relevant to petitioner's analysis. It is entitled “Special rule for payments from foreign parents to domestic subsidiaries” and contains no text. The Secretary explicitly “[RESERVED]” the rules under that provision during the years in issue. In 1992 the Secretary promulgated new final regulations which omitted the reserved paragraph. The preamble to the new final regulations states that the Commissioner had decided not to adopt rules which look through payments from foreign parents to U.S. subsidiaries because of administrative and policy concerns. The preamble states:

To apply the look-through rules, the Service needs complete information concerning the foreign corporation's income and expenses. The Service may not be able to obtain all of the necessary information from a foreign parent corporation and to audit it. In addition, the payments generally would be deductible from taxable income of the payor that is entirely outside the jurisdiction of the United States (including subpart F) and, therefore, do not give rise to the same concerns involved in other look-through cases. [T.D. 8412, 1992–1 C.B. 273 (preamble to the 1992 final regulations).]

Petitioner further relies on the U.S.-France Treaty and more specifically the nondiscrimination provision embodied in Article 24(3),which provides:

A corporation of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected...