Doyle v. Comm'r of Internal Revenue

• Citation: 79 T.C. 101
• Decision Date: 21 July 1982
• Docket Number: Docket No. 14077-78.
• Parties: DOYLE, DANE, BERNBACH, INC. (AND DOMESTIC SUBSIDIARIES), PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

79 T.C. 101

DOYLE, DANE, BERNBACH, INC. (AND DOMESTIC SUBSIDIARIES), PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 14077-78.

United States Tax Court

Filed July 21, 1982.

Held, in order to satisfy the “all events” test of sec. 1.451-1(a), Income Tax Regs., the proper year for P, an accrual method taxpayer, to include in income refunds of New York State franchise taxes and New York City corporation taxes is the year the right to those refunds is ultimately determined. Held, further: In applying sec. 862(b), I.R.C. 1954, as amended, to decide whether a deduction is allocable to foreign source income, the test is whether the expense, loss, or other deduction was incurred to derive income from such foreign source. Because the proceeds of the loan P, as guarantor, was obligated to pay for its West German subsidiary were to be used by the subsidiary as working capital, P's bad debt deduction resulting from payment of that obligation is allocable to foreign source income. Leonard A. Blank and David Zack, for the petitioner.

Barry C. Feldman, for the respondent.

OPINION

TIETJENS , Judge:

Respondent determined a deficiency of $394,887 in petitioner's Federal income tax for the year ended October 31, 1972. After concessions by the parties, the issues for decision are (1) whether, as an accrual method taxpayer, petitioner must include in its gross income amounts representing claimed refunds of New York State franchise taxes and New York City general corporate taxes for the taxable year ended October 31, 1972, attributable to a net operating loss carryback from the taxable year ended October 31, 1975; and (2) whether, under sections 861 and 862,¹ the bad debt deduction which resulted from petitioner's payment on its guaranty of a loan to its wholly owned foreign subsidiary is allocable to foreign source income thereby reducing the maximum allowable foreign tax credit available to petitioner under section 904.

This case was fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure.² The stipulation of facts and exhibits are incorporated herein by reference. Petitioner and its domestic subsidiaries timely filed consolidated Federal corporate income tax returns for the taxable years ended October 31, 1972, and October 31, 1975, with the Director, Brookhaven Service Center.

Petitioner's return for the taxable year ended October 31, 1975, reflected a net operating loss of $1,891,413. On or about January 23, 1976, petitioner filed Form 1139, seeking to carry back the net operating loss of the taxable year ended October 31, 1975, to the taxable year ended October 31, 1972, as well as to carry back an unused investment credit from 1975 to 1972. A refund of $918,786, plus statutory interest, subsequently was tentatively allowed.

On October 31, 1975, based on the carryback of its net operating loss, petitioner was entitled to file claims for a refund of New York State franchise taxes and New York City general corporation taxes, for the taxable year ended October 31, 1972. New York State tax law and the regulations issued thereunder, as well as similar provisions applicable to the New York City general corporation tax, provide limitations on the amount of a net operating loss which may be carried back.³ According to the New York Tax Law article 27, section 1086, the New York State Tax Commission has the right to examine any refund claim before determining whether to allow such claim and the amount. A similar procedure exists with respect to the New York City general corporation tax. N.Y. City Admin. Code sec. R46-67.0.1. See also N.Y. City Admin. Code sec. R46-77.0.

Based upon the net operating loss carryback from 1975,⁴ some time after October 31, 1975, petitioner filed a claim for refund of New York State franchise taxes for the taxable year ended October 31, 1972, in the amount of $419,949 and a similar claim for refund of New York City taxes in the amount of $334,916. Consequently, petitioner received a check from New York State in an amount approximating that which had been claimed. No refund, however, had been received from New York City.

Respondent examined petitioner's Federal income tax returns for the taxable years ended October 31, 1972, and October 31, 1975, and adjustments to income were made totaling $331,319 for the taxable year ended October 31, 1972, and $5,916 for the taxable year ended October 31, 1975. Petitioner had claimed and respondent had allowed a deduction for the New York State franchise taxes and the New York City general corporation taxes sought to be refunded for the taxable year ended October 31, 1972, on petitioner's Federal return filed for that year.

Petitioner filed its returns using the accrual method of accounting.

In or about April 1973, Snark Products GmbH (Snark), a wholly owned foreign subsidiary of the petitioner with offices in Germany, secured a loan from the Chase Manhattan Bank, N.A. Petitioner was required to execute a guaranty of the loan to Snark exposing it to a maximum liability of 2 million Deutsche marks. Negotiations incident to the securing of the loan and the guaranty occurred in New York, N.Y. The loan proceeds were to be used by Snark for its working capital and were to be delivered to Snark at a branch of the Chase Manhattan Bank in Germany. Snark did no business in the United States.

Snark defaulted on payment of the loan and petitioner was required to, and did, pay $854,761 to the Chase Manhattan Bank, N.A., pursuant to the terms of the guaranty. The parties agree that petitioner is allowed a bad debt deduction in that amount in the taxable year ended October 31, 1975.⁵

Petitioner calculated the foreign tax credit under the per-country limitation method in the return for its taxable year ended October 31, 1972. Its gross income from West German sources for the taxable year ended October 31, 1975, was $587,791; the amount of its total gross income for that year being dependent upon a resolution of the first issue herein is either $37,118,682 (petitioner's figure) or an amount reflecting the inclusion of $419,273 and $334,937 in State and local tax refunds (respondent's position).

Firstly, petitioner argues that because its New York State and City refunds could have been disallowed in whole or in part as a result of an examination by the New York State Tax Commission, the New York City Department of Finance, or the Internal Revenue Service, all events fixing the right to such refunds had not occurred at October 31, 1975, and because, similarly, the amount thereof could not be determined with reasonable accuracy, petitioner, an accrual method taxpayer, should not include such potential tax refunds in its income for that year. Secondly, petitioner contends that the bad debt it suffered on its guaranty of the loan to Snark is allocable to U.S. sources because negotiations incident to the securing of the loan and the guaranty occurred in New York, N.Y., and, like gains from the sale of personal property which are derived entirely within the country in which the property is sold, losses from bad debts should be treated as allocated specifically to the country where transactions effecting the loss occurred. Alternatively, petitioner asserts that this bad debt deduction should be apportioned on the basis of the ratio of gross income from West German sources to total gross income.

Respondent, by contrast, maintains, pursuant to section 451 and section 1.451-1(a), Income Tax Regs., that by the end of the taxable year ended October 31, 1975, all events had occurred which fixed petitioner's right to receive the New York State and City tax refunds and that the amounts could be determined with reasonable accuracy; therefore, respondent states petitioner must include the refunds in income for that year thereby reducing the available net operating loss carryback. Moreover, respondent argues that with regard to petitioner's guaranty of the loan to Snark, petitioner has not proved that the bad debt deduction was not allocable to foreign source income from Germany since, respondent contends, the place of negotiation is irrelevant and the purpose for which the funds were used is determinative.

Section 1.451-1(a), Income Tax Regs., provides that an accrual method taxpayer must include income in gross income both when all events fixing the right to receive tax income have occurred and when the amount of such income can be determined with reasonable accuracy.

Respondent's position, as stated in Rev. Rul. 65-190, 1965-2 C.B. 150, is that, for Federal income tax purposes, an accrual method taxpayer must include in income a refund of New York State corporation franchise taxes, resulting from a net operating loss carryback, in the taxable year of the loss effecting such a refund. The ruling requires inclusion in income in that year even though third persons might need to perform additional acts as long as it is reasonable to expect that these acts will be completed.

On the other hand, respondent's position in Rev. Rul. 62-160, 1962-2 C.B. 139, is that interest on a refund of Federal tax accrues when a taxpayer's right to receive such refund is ultimately determined. According to the ruling, the year of inclusion is the year that an authorized representative of the Internal Revenue Service certifies the allowance of an overassessment in respect of the tax.⁶

We need not dwell upon the seeming inconsistency between these two rulings because in the final analysis neither of them is binding upon us. See Theo. H. Davies & Co. v. Commissioner, 75 T.C. 443, 448 (1980), affd. per curiam 678 F.2d 1367 (9th Cir. 1982). To be sure, Rev. Rul. 65-190, supra, is of long standing and has been reaffirmed by Rev. Rul. 69-372, 1969-2 C.B. 104. But the fact of the matter is that Rev. Rul. 65-190, supra, by its very terms assumes “the validity of the taxpayer's transactions and the correctness of the figures so established.” See Rev. Rul. 65-190, s...