Gehl Co. v. C.I.R.
| Decision Date | 10 July 1986 |
| Docket Number | No. 85-1326,85-1326 |
| Parties | -5423, 86-2 USTC P 9530 GEHL COMPANY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Davit S. Lott, Foley & Lardner, Milwaukee, Wis., for petitioner-appellant.
David English Carmack, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.
Before CUMMINGS, Chief Judge, COFFEY, Circuit Judge, and WILL, Senior District Judge. *
This case comes to us on appeal from the United States Tax Court, which found in favor of the respondent Commissioner of Internal Revenue ("Commissioner") against the petitioner Gehl Company ("Gehl"). The first issue raised is whether Treasury Regulation Sec. 1.993-2(d)(2), which sets down rules limiting the classification of commissions owed to a domestic international sales corporation ("DISC") as "qualified export assets" as that term is defined by Section 993(b) of the Internal Revenue Code, 1 is a valid regulation. A second related issue is, assuming that the cited Treasury regulation is valid, whether that regulation can be applied retroactively. For the reasons set forth below, we agree with the Tax Court that Treasury Regulation Sec. 1.993-2(d)(2) is valid but disagree that it can be applied retroactively.
Since the facts have been fully stipulated, only a brief summary is necessary. Gehl and Gehl International, Inc. ("International") are both corporations organized under the laws of Wisconsin, and at all relevant times International was wholly owned by Gehl. During the relevant time period, Gehl was engaged in the manufacture, domestic sale and export of agricultural machinery and equipment. In 1972 International elected to be treated as a DISC under the Internal Revenue Code. International's sole function was to act as a commission agent for items it exported on Gehl's behalf; i.e., a so-called "commission agent DISC." See, e.g., Rendell, Use of a Domestic International Sales Corporation to Reduce Federal Income Tax on Export Earnings, 11 San Diego L.Rev. 138, 145-146 (1973). Gehl is a related supplier with respect to International. Commissions were to be paid each month from Gehl to International on all qualified export sales made during the month at the rate of four and one-half percent. Gehl and International utilized the accrual method of accounting. Gehl operates on a calendar year, while International's fiscal year ends on January 31.
At issue is International's qualification as a DISC under Section 992 for its taxable years ended January 31 of 1976, 1977, 1978, and 1979. The adjusted basis of International's total assets on the dates listed below was as follows:
The accrued commissions owed to International by Gehl on the dates listed below were as follows:
As the above illustrates, the commissions receivable of International at the close of its taxable years ended January 31, 1976, 1977, 1978, and 1979, were not fully paid by Gehl within sixty days of such dates (by March 30, 1976, 1977, 1978, and 1979, respectively). Specifically, by sixty days after the close of those tax years, Gehl had paid only .44 percent, 1.41 percent, .20 percent, and 1.50 percent, respectively, of the accrued commissions for those years. The commissions were fully paid, however, by the respective due dates of International's returns for such years (October 15, 1976, 1977, 1978, and 1979). 2
The basis for the pertinent adjustments in the Commissioner's notice of deficiency to Gehl was his determination that International did not qualify as a DISC under Section 992 for its tax years ended January 31, 1976, 1977, 1978, and 1979. The Commissioner's determination was based on his position that International did not satisfy the 95 percent "qualified export assets" test of Section 992(a)(1)(B), because its commissions receivable from Gehl on January 31, 1976, 1977, 1978, and 1979, were not paid within sixty days of those dates, as required by Treasury Regulation Sec. 1.993-2(d)(2), 3 and thus did not constitute "qualified export assets" under Section 993(b).
The Tax Court upheld the Commissioner's determination. The Tax Court rejected Gehl's argument that the sixty-day payment requirement of the regulations was invalid. Additionally, the Tax Court rejected Gehl's argument that it had substantially complied with this regulatory requirement and that nothing more was necessary. From the decision entered against Gehl, this appeal followed.
Before answering the specific issue raised in this case, we briefly review the DISC provisions of the Code as a whole so that it may be better determined whether the challenged regulation comports with the overall statutory scheme.
The DISC legislation was passed as part of the Revenue Act of 1971. 4 Generally speaking, a DISC is a domestic corporation whose income is derived mostly from sale and lease transactions and whose properties consist chiefly of "qualified" export-related assets. Bittker & Eustice, FEDERAL INCOME TAXATION OF CORPORATIONS AND SHAREHOLDERS p 17.14.1 (4th Ed.1979) (). The principal function of a DISC under the basic definitional terms set out in 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." Bittker & Eustice p 17.14.2. To qualify as a DISC, a corporation must satisfy several requirements, including two basic definitional elements: the "export receipts" test (Section 992(a)(1)(A)), and the "export assets" test (Section 992(a)(1)(B)). The first test requires 95 percent of a DISC's gross receipts to be, generally speaking, receipts that derive from export sales or lease transactions, and from certain export-related activities or investments ("qualified export receipts"). Bittker & Eustice p 17.14.2. The second test, and the test at issue in the instant case, requires 95 percent of a DISC's assets at the close of its taxable year to be, generally speaking, export-related properties, "such as property held for sale or lease abroad, and the nonmanufacturing operating assets associated with such export activities" ("qualified export assets"). Id. A corporation that meets these two tests will thus fulfill the principal function of a DISC as described above.
Several parts of the DISC provisions regulate transactions and transfers involving the flow of the DISC's tax-deferred profits to related entities in order to preserve the integrity of the DISC's basic definitional elements described above. One important concept in this regard is the "producer's loan," defined in Section 993(d). This is a loan by a DISC, from its tax-deferred profits, to an affiliated U.S. parent corporation producer of export property (in this case a loan from International to Gehl). Such a loan must meet many rules to qualify as a producer's loan, and only if it so qualifies can the DISC include the loan as a qualified export asset, Section 993(b)(5), and the interest on the loan as qualified export receipts, Section 993(a)(1)(F). Bittker & Eustice p 17.14.2. Another section which serves this purpose is Section 994, which sets forth special inter-company pricing rules regulating sales by a related supplier such as Gehl to a DISC such as International, and the allocation of profits between them. See generally Bittker & Eustice p 17.14.3. More precisely, Section 994(b) and Treasury Regulation Sec. 1.994-1(e)(3) govern payments from a related supplier to the DISC in a transaction to which the inter-company pricing rules apply.
If a corporation qualifies as a DISC, then it is entitled to certain income tax benefits. In particular, such a corporation is not subject to federal income tax at the corporate level. Instead, roughly one-half of a DISC's earnings are taxed currently to its shareholders as constructive dividends, regardless of whether such earnings are actually distributed. Bittker & Eustice p 17.14.1. The remainder of a DISC's earnings are not taxable to its shareholders until the earnings are actually distributed to them, or the shareholders dispose of their stock in a taxable transaction, or the corporation no longer qualifies as a DISC, at which time the earnings are taxed at the shareholder level as a dividend. Id. "In effect,...
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