Good Fortune Shipping SA v. Comm'r of Internal Revenue

• Decision Date: 27 July 2018
• Docket Number: No. 17-1160,17-1160
• Parties: GOOD FORTUNE SHIPPING SA, Appellant v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee
• Court: U.S. Court of Appeals — District of Columbia Circuit

897 F.3d 256

GOOD FORTUNE SHIPPING SA, Appellant

v.COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee

No. 17-1160

United States Court of Appeals, District of Columbia Circuit.

Argued April 26, 2018

Decided July 27, 2018

Stephen P. Flott, Arlington, VA, argued the cause for appellant. With him on the briefs were Joseph G. Siegmann and Brittany N. Oravec.

Richard Caldarone, Attorney, U.S. Department of Justice, argued the cause for appellee. With him on the brief were David A. Hubbert, Deputy Assistant Attorney General, and Thomas J. Clark, Attorney.

Before: Garland, Chief Judge, and Griffith and Srinivasan, Circuit Judges.

Griffith, Circuit Judge:

In 2007, the foreign shipping corporation Good Fortune Shipping SA ("Good Fortune") attempted to exempt some of its U.S.-based income from taxation. But in order to qualify for the exemption, a certain percentage of Good Fortune’s stock needed to be owned by residents of a country that provided a reciprocal tax exemption. At that time, the Internal Revenue Service (IRS) categorically prohibited any consideration of bearer shares—securities owned by whoever holds physical certificates issued by the company—when assessing whether a sufficient amount of a foreign shipper’s stock was owned by qualifying shareholders. The IRS refused to grant Good Fortune the exemption because all of the company’s stock was made up of bearer shares. Good Fortune challenged the IRS’s approach as inconsistent with the Internal Revenue Code, and the Tax Court ruled in favor of the IRS. Because the IRS’s regulation prohibiting consideration of bearer shares unreasonably interpreted the Code, we reverse.

I

A

Under the Internal Revenue Code (the "Code"), foreign corporations generally must pay tax on any income derived from operating ships that transport goods to or from the United States (called "United States source gross transportation income"). I.R.C. § 887(a). However, the Code also historically exempted the income of certain foreign shippers from this tax. Prior to 1986, federal law exempted a foreign corporation’s shipping income so long as the corporation registered its ships in a country that granted "equivalent tax exemptions to U.S. citizens and U.S. corporations." H.R. Rep. No. 99-841, at 597 (1986) (Conf. Rep.). This exemption applied "without regard to the residence of persons receiving the exemption or whether commerce is conducted in the country of registry." S. Rep. No. 99-313, at 340 (1986).

This exemption did not work as effectively as Congress had anticipated. Members of Congress had hoped that the registration-based exemption would encourage the "international adoption of uniform tax laws" that eliminated the prospect of double taxation from shippers’ home countries and their countries of operation. S. Rep. No. 67-275, at 14 (1921). Although U.S. shippers were required to pay U.S. tax on their income, foreign shippers could avoid the U.S. tax by simply registering (or "flagging out") their ships in a country that provided a reciprocal exemption, regardless of whether the ships’ owners had any connection to that country. See S. Rep. No. 99-313, at 340-41. Congress ultimately found that this registration-based exemption "place[d] U.S. persons with U.S.-based transportation ... at a competitive disadvantage" compared to foreign shippers who claimed the U.S. exemption and were not taxed by either their countries of residence or registration. Id. at 340.

Congress therefore tightened the exemption in the Tax Reform Act of 1986, Pub. L. No. 99-514, § 1212, 100 Stat. 2085, 2536-37. After the 1986 Act, the Code places a four-percent tax on the U.S. source gross transportation income of nonresident alien individuals and foreign corporations. See I.R.C. § 887(a). Congress in 1986 replaced the registration-based exemption with a new residency-based exemption for foreign shippers. A foreign shipper can qualify for the new exemption only if it is "organized in a foreign country" that "grants an equivalent exemption to corporations organized in the United States." Id. § 883(a)(1). However, even a foreign shipper organized in such a country is ineligible for the exemption "if 50 percent or more of the value" of its stock "is owned by individuals who are not residents" of a country providing a reciprocal exemption. Id. § 883(c)(1).

In 2003, the IRS promulgated a regulation elaborating on the statutory requirement that residents of a country providing a reciprocal exemption own more than half of the foreign shipper’s stock. See Exclusions from Gross Income of Foreign Corporations, 68 Fed. Reg. 51,394 (Aug. 26, 2003) (the "2003 Regulation"). To qualify as an exempted foreign corporation under the 2003 Regulation, a shipper must satisfy the "qualified shareholder test." Under that test, an exempted corporation must prove, among other things, that "more than 50 percent of the value of its outstanding shares is owned" by qualified shareholders, either directly or indirectly through application of attribution rules, "for at least half of the number of days in the foreign corporation’s taxable year." 26 C.F.R. § 1.883-4(a) (2007). An individual is a "qualified shareholder" only if, among other things, he is a resident of a reciprocating country. Id. § 1.883-4(b)(1)(i)(A). And a foreign-corporation shareholder qualifies only if it is organized in a reciprocating country. Id. § 1.883-4(b)(1)(i)(C).

Generally, a foreign corporation claiming an exemption under the qualified shareholder test "must establish all the facts necessary to satisfy the [IRS] that more than 50 percent of the value of its shares is owned ... by qualified shareholders." Id. § 1.883-4(d)(1). When it comes to establishing the facts necessary to demonstrate corporate ownership, the 2003 Regulation treats differently "bearer shares" and "registered shares" of corporate stock. Bearer shares are owned by the "physical bearer of the stock certificate" and traditionally have "no recorded ownership information." Black’s Law Dictionary (10th ed. 2014). On the other hand, "registered shares" are securities "recorded in the issuer’s books." Id. Under the 2003 Regulation, a corporation could prove it met § 883(c)(1)’s ownership requirement by submitting company records proving up registered shareholders’ identities and countries of residence. See 26 C.F.R. § 1.883-4(d)(4). But a qualified shareholder may not "own its interest in the foreign corporation through bearer shares." Id. § 1.883-4(b)(1)(ii) ; see also id. § 1.883-4(c)(1) ("No attribution will apply to an interest held directly or indirectly through bearer shares."); id. § 1.883-4(d)(1) ("A foreign corporation cannot meet [the stock ownership] requirement with respect to any stock that is issued in bearer form. A shareholder that holds shares in the foreign corporation either directly or indirectly in bearer form cannot be a qualified shareholder."). The IRS drew this distinction and prohibited the use of bearer shares because of "the difficulty of reliably demonstrating the true ownership of bearer shares." 68 Fed. Reg. at 51,399. The 2003 Regulation provided no further explanation for the categorical exclusion of bearer shares.

B

Good Fortune is a corporation organized under the laws of the Republic of the Marshall Islands. The Marshall Islands offers a reciprocal exemption to U.S. shippers sufficient to satisfy § 883(a)(1). See Rev. Rul. 2001-48, tbl. I.A, 2001-2 C.B. 324 ; Rev. Rul. 2008-17, tbl. I.A, 2008-1 C.B. 626. During the 2007 tax year, all of Good Fortune’s outstanding stock was composed of bearer shares, issued as physical certificates for which neither Good Fortune nor any financial institution maintained any formal records of ownership or transfer.

For the 2007 tax year, Good Fortune reported slightly less than $4.1 million in U.S. source gross transportation income. That income would have been taxable under I.R.C. § 887, unless it qualified for the exemption in § 883(a)(1). Good Fortune claimed that the income qualified for that exemption and provided documentation purporting to show that all of its bearer shares were indirectly owned by individuals residing in countries that provide a reciprocal exemption to U.S. corporations. Good Fortune also argued that the 2003 Regulation prohibiting any consideration of bearer shares was unlawful.

The IRS sent Good Fortune a notice of deficiency for the 2007 tax year reflecting the IRS’s determination that Good Fortune’s U.S. source gross transportation income for that year was about $3.6 million, not $4.1 million. The IRS also determined that none of that income could be exempted presumably because all of Good Fortune’s stock had been issued as bearer shares and the 2003 Regulation prohibited their consideration. The IRS accordingly determined that Good Fortune had an income tax deficiency of approximately $143,500 for the 2007 tax year.

Good Fortune then filed a petition in the Tax Court for a redetermination of its 2007 deficiency. The company conceded that it could not qualify for the § 883(a)(1) exemption under the 2003 Regulation but asserted that the regulation’s categorical exclusion of bearer shares was an impermissible interpretation of § 883. The Commissioner filed a motion for summary judgment and Good Fortune filed a cross-motion for the same.

The Tax Court granted the Commissioner’s motion and ordered Good Fortune liable on its 2007 tax deficiency. Applying the well-worn framework from Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc. , 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984), the Tax Court found that Congress had not "directly spoken to the precise question at issue," id. at 842, 104 S.Ct. 2778, namely, "how to establish ownership by individuals for the purposes of section 883(c)(1)" or "how to establish ownership where the shares of the foreign corporation are owned in bearer form," Good Fortune Shipping SA v. Comm’r , 148 T.C. No. 10, slip op. at 32 (Mar. 28, 2017).

Having found the statute silent or...