HMW Industries, Inc. v. Wheatley, Civ. No. 231/1973.

• Citation: 368 F. Supp. 915
• Decision Date: 13 December 1973
• Docket Number: Civ. No. 231/1973.
• Parties: HMW INDUSTRIES, INC., Petitioner, v. Rueben B. WHEATLEY, Commissioner of Finance, Respondent.
• Court: U.S. District Court — Virgin Islands

368 F. Supp. 915

HMW INDUSTRIES, INC., Petitioner, v. Rueben B. WHEATLEY, Commissioner of Finance, Respondent.

Civ. No. 231/1973.

District Court, Virgin Islands, D. St. Croix.

December 13, 1973.

Bryant, Costello & Burke, Christiansted, St. Croix, V. I., for plaintiff.

Verne Hodge, Atty. Gen., Charlotte Amalie, St. Thomas, V. I., for defendant.

MEMORANDUM OPINION AND JUDGMENT

WARREN H. YOUNG, District Judge.

This action brings into question the proper treatment for Internal Revenue purposes of subsidies granted under Act No. 224, the 1957 forerunner to our present Industrial Incentive Program legislation. More specifically, the issue presented is whether subsidies paid under Act No. 224 are non-shareholder contributions to capital subject to the tax treatment prescribed by Section 362(c)(2) of the Internal Revenue Code.

I. THE FACTS

Petitioner, HMW Industries, Inc., is a Pennsylvania corporation formerly known as Hamilton Watch Company. Prior to August 4, 1969, petitioner owned all of the outstanding stock of Standard Time Corporation ("STC"), a Virgin Islands corporation. On August 4, 1969, STC was liquidated and its assets were distributed to petitioner in a transaction qualifying under Section 332 of the Internal Revenue Code for nonrecognition of gain or loss. Under Section 334(b)(1), then, the basis of STC's assets in petitioner's hands was the same as STC's basis in those assets prior to the liquidation. Relying on this carryover basis, petitioner computed its income tax liability for the period August 5, 1969 through January 31, 1970, using STC's basis in its inventory as its tax basis for opening inventory. By thirty-day letter dated June 2, 1972, a deficiency of $181,548.80 was proposed in petitioner's income tax liability. The entire deficiency was based on respondent's contention that subsidies received by STC under Act No. 224 were non-shareholder contributions to capital, reducing STC's basis in its inventory and therefore petitioner's opening carryover inventory basis as well. This reduction in the basis of opening inventory had the effect of decreasing petitioner's cost of goods sold, thereby increasing its taxable income for the fiscal year ended January 31, 1970.

II. STC SUBSIDY UNDER ACT NO. 224

STC was granted its subsidy under Act No. 224 on August 6, 1959. It is logical to begin my analysis of the question presented here with an examination of the law as it existed at that time. Since the Naval Appropriations Act of 1921 the income tax laws of the United States have been applicable to the Virgin Islands. Section 1397 of Title 48 of the United States Code has, from 1921 to the present, provided that:

The income tax laws in force in the United States of America and those which may hereafter be enacted shall be held to be likewise in force in the Virgin Islands of the United States, except that the proceeds of such taxes shall be paid into the treasuries of said islands.

Although the income tax laws of the United States were made applicable to the Virgin Islands, it was still necessary for taxpayers to file two returns: one with the United States and one with the Virgin Islands, with a foreign tax credit on the U.S. return for tax attributable to Virgin Islands income. Int.Rev.Code of 1954, § 901(b)(1). The necessity for double returns was eliminated in the case of permanent residents of the Virgin Islands by the Revised Organic Act of 1954. Section 28(a) of that law provided that inhabitants of the Virgin Islands "shall satisfy their income tax obligations under applicable taxing statutes of the United States by paying their tax on income derived from all sources both within and outside the Virgin Islands into the treasury of the Virgin Islands."

In 1959, then, the Virgin Islands Income Tax law mirrored that of the United States. 33 V.I.C. § 1931(15). The Virgin Islands was a "distinct taxing jurisdiction" although its income tax law arose from the identical statute applicable in the United States. Dudley v. Comm'r of Internal Revenue, 258 F.2d 182, 185, 3 V.I. 685, 691 (3d Cir. 1958). Given this incorporation of United States income tax law as the territorial income taxing statute, it becomes necessary to inquire whether the legislature of the Virgin Islands was empowered to affect in any way, by modification or addition, the impact of this law on a corporation such as STC. This question is of substantial importance because it appears that such a modification of the effect of the income tax law was attempted by the legislature in passing Act No. 224.

Act No. 224 was designed to extend such inducements and render such aid as necessary to encourage corporations and others to establish and develop new business enterprises in the Virgin Islands. In addition to providing exemptions from specifically listed, locally imposed taxes, a special "nontaxable subsidy" in the amount of 75% of the income tax paid into the Treasury of the Virgin Islands was granted. Act No. 224, Section 6(a), Virgin Islands Session Laws 1957 at 150. Because the exemption from property taxes, gross receipts taxes and other locally imposed taxes were specifically and separately granted, the legislature's provision that the subsidy was to be "nontaxable" must have had reference to the income tax imposed under the Internal Revenue Code as made applicable to the Virgin Islands. The effect of the subsidy then, would be to reduce by 75% the income tax liability of certain grantees under the Act. The clear intention of the legislature (and understanding by corporations induced to establish businesses in the Virgin Islands) was that this "subsidy" was to be a reduction of income taxes. This intention would be frustrated by a ruling that the payments constituted non-shareholder contributions to capital, reducing the basis of the grantees assets and in many cases causing an immediate increase in taxable income in the amount of the subsidy. But the intention of the Virgin Islands legislature as expressed in Act No. 224 becomes irrelevant if that body lacked the power to alter the effect of the income tax law in the manner attempted.

In analyzing this question of power it is important to note that the incorporation of the Internal Revenue Code into Virgin Islands law differs from ordinary cases of incorporation encountered by courts. When one jurisdiction voluntarily adopts the statutory language of another, it, of course, retains the power to alter the law in the future. Moreover, legislatures often intend merely a verbal incorporation of another jurisdiction's statute and reserve the right, in their courts, to interpret the law differently from the way in which it applied in the original drafting jurisdiction. But here, my analysis cannot take place within the same framework which two separate independent jurisdictions present; nor does this case represent the ordinary voluntary incorporation. Instead, the statute in question was imposed by the Congress of the United States on a territory pursuant to its constitutional power to make rules and regulations concerning the territories. U.S.Const. Art. 4, § 3, cl. 2. When the Congress enacts the Internal Revenue Code as the income tax law for the Virgin Islands it acts as the exclusive sovereignty having absolute and undisputed power of governing and legislating for the territory. United States v. Kagama, 118 U.S. 375, 96 S.Ct. 1109, 30 L.Ed. 228 (1886); Sere v. Pitot, 10 U.S. 332, 3 L. Ed. 240 (1810). If it denies the territorial legislature the power to vary the effect of the law on individual taxpayers, the power does not exist and cannot be exercised.

The question, then, when viewing the problem as of 1959 when the STC subsidy was granted is whether the Congress had denied the Virgin Islands legislature the power to legislate a reduction in income tax liability. Section 1397 which provides that the income tax laws of the United States "shall be held to be likewise in force in the Virgin Islands" does not explicitly deny the Virgin Islands legislature this power. But where Congress enacts such a pervasive scheme of taxation for the territory, an intention to preempt the field and deny authority to vary the statute's effect may be implied. See Bethlehem Steel Co. v. New York State Labor Relations Bd., 330 U. S. 767, 67 S.Ct. 1026, 91 L.Ed. 1234 (1947); Napier v. Atlantic Coast Line R.R., 272 U.S. 605, 47 S.Ct. 207, 71 L. Ed. 432 (1926); Northern States Power Co. v. Minnesota, 447 F.2d 1143 (8th Cir. 1971). Indeed, preemption may more readily be implied when a territory is involved because its legislative power derives solely from a permissive act of Congress (Revised Organic Act of 1954, § 8(a)) and no problem of "dual sovereignties" is presented. See California State Bd. of Equalization v. Goggin, 191 F.2d 726 (9th Cir.), cert. denied, 342 U. S. 909, 72 S.Ct. 302, 96 L.Ed. 680 (1951).

Before concluding too rapidly that Congress intended to deny the Virgin Islands legislature authority to affect the operation of the Internal Revenue Code in the territory, the general purpose for making the U.S. income tax law applicable in the Virgin Islands and payable directly to the territory should be examined. It has been observed by several Courts that Congress acted in order "to assist the Islands in becoming self-supporting." Dudley, supra, 3 V.I. at 691, 258 F.2d at 185; Chicago Bridge & Iron Co., Ltd. v. Wheatley, 295 F.Supp. 240, 242, 7 V.I. 126, 131 (1969). Certainly, the large revenues produced by the income tax were thought to be and are of great aid to the Virgin Islands in its efforts to develop economically. But the legislature of the Virgin Islands determined that the future interests of the Islands were better served by offering the incentive of a temporary reduction in tax liabilities to new businesses than by collecting the entire tax from those taxpayers already present in the territory. This effort was entirely compatible with the intention of Congress...