Polychrome Intern. Corp. v. Krigger

Decision Date10 September 1993
Docket Number92-7510,Nos. 92-7509,s. 92-7509
Citation5 F.3d 1522
Parties-6319, 94-1 USTC P 50,084 POLYCHROME INTERNATIONAL CORPORATION v. Rudolph E. KRIGGER, Commissioner of Finance, Eric Dawson, Commissioner of Economic Development and Agriculture, Government of the Virgin Islands. CAMCO INTERNATIONAL, LIMITED v. Rudolph E. KRIGGER, Commissioner of Finance, Clement Magras, Commissioner of Licensing and Consumer Affairs, Derek M. Hodge, Lieutenant Governor, Eric Dawson, Commissioner of Economic Development and Agriculture. Rudolph E. Krigger, Commissioner of Finance, Eric Dawson, Commissioner of Economic Development and Agriculture, Clement Magras, Commissioner of Licensing and Consumer Affairs, Derek M. Hodge, Lieutenant Governor, Appellants in 92-7509. Polychrome International Corporation; Camco International, Limited, Appellants in 92-7510.
CourtU.S. Court of Appeals — Third Circuit

Joseph M. Erwin (argued), Office of Attorney General of the Virgin Islands, Dept. of Justice, Charlotte Amalie, St. Thomas, U.S. Virgin Islands, for appellants/cross-appellees, Rudolph E. Krigger, Commissioner of Finance, Eric Dawson, Commissioner of Economic Development and Agriculture, Clement Magras, Commissioner of Licensing and Consumer Affairs, Derek M. Hodge, Lieutenant Governor.

Gustav A. Danielson (argued), Law Offices of Robert L. King, Charlotte Amalie, St. Thomas, U.S. Virgin Islands, for appellees/cross-appellants, Polychrome Intern. Corp.; Camco Intern., Ltd.

Before: GREENBERG, SCIRICA and GARTH, Circuit Judges.


SCIRICA, Circuit Judge.

In these consolidated class actions, Polychrome International Corporation and Camco International, Ltd. challenge certain Virgin Islands statutes imposing taxes and fees on "Foreign Sales Corporations." Seeking a refund and a permanent injunction against future assessments, they claim the statutes violate the United States Constitution, as well as United States and Virgin Islands law. 1 On cross-motions for summary judgment, the district court granted the Government's motions on all of plaintiffs' claims except one, on which it granted summary judgment for plaintiffs. All parties appeal. We will affirm in part and reverse in part.


The challenged provisions of the Virgin Islands Code were enacted in response to, and in coordination with, a special Subpart of the Internal Revenue Code (IRC) entitled "Taxation of Foreign Sales Corporations," 26 U.S.C. Secs. 921-27 (1988 & Supp.1993). As necessary background, we begin with a brief discussion of the history, purpose, and operation of IRC Secs. 921-27.


In an attempt to rectify trade imbalances, Congress has, since 1972, provided tax incentives for certain corporations engaged in export activities. Originally, Congress established a system of tax deferral for "Domestic International Sales Corporations," or DISCs. 2 Under pressure from signatories to the General Agreement on Tariffs and Trade, 3 Congress supplanted this legislation in 1984 with special provisions for "Foreign Sales Corporations," or FSCs, 26 U.S.C. Secs. 921-27. 4 See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2d Sess., at 1041-42 (CCH 1985). These provisions allow American companies to exempt part of their export income from taxation, through the use of foreign subsidiaries.

A FSC (pronounced "fisk") is a subsidiary of an American corporation, organized under the laws of any qualified foreign country or eligible U.S. possession. 5 Typically, a FSC either buys goods from its American parent for resale (a "buy-sell" FSC) or takes the goods as a resale agent, receiving a commission for any such resale (a "commission" FSC). See generally Boris I. Bittker & James S. Eustice, Federal Income Taxation of Corporations and Shareholders, p 17.14(3) (3d ed. 1987).

All FSCs must satisfy certain organizational and operating requirements to qualify for the IRC's partial tax exemption. In terms of organization, FSCs must have no more than 25 shareholders, have no outstanding preferred stock, maintain an office and books of account outside the U.S., have at least one non-U.S.-resident board member, and elect FSC status. IRC Sec. 922(a). FSCs must also perform certain management functions outside the United States. See IRC Secs. 924(b), (c), (d). Its directors' board meetings must comply with the laws of its home jurisdiction, and it must keep its primary bank account outside the United States. See 26 C.F.R. Sec. 1.924(c) (1993). If the FSC satisfies these requirements, a portion of its income is exempted from taxation. See I.R.C. Secs. 921(a), 923, 924; see also 26 C.F.R. Sec. 1.923- 1T(b)(1)(iii) (1993). 6


Because FSCs are incorporated abroad, the benefits afforded by the IRC may be reduced or eliminated if FSC-host countries impose stiff taxes on FSC income. See generally Blake A. Bernet, The Foreign Sales Corporation Act: Export Incentive for U.S. Business, 25 Int'l Law 223 (1991). Congress prevented such taxation in U.S. territories, on which it may impose all "needful Rules and Regulations," U.S. Const. art. IV, Sec. 3, cl. 2, by establishing a temporary tax holiday for FSCs incorporated there. Under IRC Sec. 927(e)(5)(A), Congress provided "[n]o tax shall be imposed by any possession of the United States on any foreign trade income derived before January 1, 1987." To encourage territories to extend favorable tax treatment to FSCs, Congress also provided: "[n]othing in any provision of law shall be construed as prohibiting any possession of the United States from exempting from tax" any foreign trade income, interest income, and carrying charges 7 of a FSC. IRC Sec. 927(e)(5)(B).

Because FSCs may generate significant revenue, many U.S. possessions and foreign jurisdictions attempted to lure them by creating special tax incentives. See Bernet, supra; see also Walter H. Diamond, Foreign Sales Corporations: Final IRS Regulations and Host Government Incentives xii (1987). The Virgin Islands has been particularly effective in attracting FSCs, see Bernet, supra (82% of FSCs world-wide are incorporated in the U.S. Virgin Islands); Edward E. Thomas, Revenue Letter to Commissioner Wetzler, 91 Tax Notes Int'l 45 (Nov. 6, 1991) (4,000 FSCs, representing 80% of FSCs world-wide, are incorporated in the U.S. Virgin Islands), and its success has been due, in part, to its scheme of FSC taxation. See Carey R. D'Avino, General Explanation of the U.S. Virgin Islands FSC Legislation, 85 Tax Notes Today 1-63 (Jan. 2, 1985) (influx of FSCs to the Virgin Islands resulted from favorable tax treatment).


As Virgin Islands corporations, FSCs would be obligated, in the absence of any special exemptions, to pay income taxes to the Virgin Islands government under the "mirror code" provision, 48 U.S.C. Sec. 1397 (1988), which makes the IRC applicable to all Virgin Islands residents. See Danbury, Inc. v. Olive, 820 F.2d 618, 620 (3d Cir.) ("to satisfy Virgin Islands tax obligations, an individual or corporation in the Virgin Islands pays taxes to the [Virgin Islands Bureau of Revenue] equivalent to taxes an individual or corporation under the same circumstances in the United States would pay to the Internal Revenue Service."), cert. denied, 484 U.S. 964, 108 S.Ct. 453, 98 L.Ed.2d 393 (1987). This provision has been incorporated into, and is the basis of, Virgin Islands income tax law. 8 33 V.I.C. Sec. 1931(15); see Abramson Enters., Inc. v. Government of Virgin Islands, 994 F.2d 140, 141-42 (3d Cir.1993); HMW Indust., Inc. v. Wheatley, 504 F.2d 146, 150 (3d Cir.1974). Although, generally, the Virgin Islands may not reduce or remit tax liability "in any way, directly or indirectly," see IRC Sec. 934(a), Congress has, as noted above, invited the Virgin Islands to exempt FSC income from taxation. See IRC Sec. 927(e)(5)(B).

Under the aegis of Sec. 927(e)(5)(B), the Virgin Islands legislature has created a special Chapter of its Corporations and Associations Law, containing tax exemptions for FSCs. See 13 V.I.C. Secs. 773-78 (Supp.1990). By its express terms, "[t]he benefits granted under this chapter ... apply only to [a] FSC incorporated in the Virgin Islands." 13 V.I.C. Sec. 771(1).

Under these provisions, Virgin Islands FSCs, and their shareholders, are exempt from several generally applicable income and property taxes. For example, no taxes are payable on foreign trade income, 9 investment income, and carrying charges 10 until January 1, 1997. 13 V.I.C. Sec. 773. Although other companies must pay a gross receipts tax on apportioned gross receipts from the sale or disposition of property (33 V.I.C. Secs. 41, 42), FSCs are exempt. 13 V.I.C. Sec. 774. Moreover, although U.S. citizens receiving distributions from Virgin Islands companies are ordinarily taxed on those distributions (26 U.S.C. Secs. 871(a)(1), 881), the Virgin Islands FSC provisions exempt U.S. residents, citizens, and companies from taxes on shareholder distributions. 13 V.I.C. Sec. 777. 11

The Virgin Islands Code also contains exemptions for FSC-held property. Import property is exempt from customs duties if the FSC intends to reexport it. 13 V.I.C. Sec. 776. FSCs are exempt from payment of excise taxes (33 V.I.C. Sec. 42) on all export property, 13 V.I.C. Sec. 775, and customs duties, which are ordinarily payable under 33 V.I.C. Sec. 525. 13 V.I.C. Sec. 776.

In order to assure FSCs that after their incorporation in the Virgin Islands these exemptions would remain inviolate, the legislature directed the Office of the Lieutenant Governor to enter a contract with every FSC upon request. 13 V.I.C. Sec. 780. The contract must specify "that the benefits of this chapter as they exist on [their] effective date ... shall be and remain available to said FSC, and shall not be reduced, until at least January 1, 1997...." Id. The contract must also provide "that the Government shall not...

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