Tate & Lyle, Inc. v. Comm'r of Internal Revenue

Decision Date15 November 1994
Docket NumberNo. 740–92.,740–92.
Citation103 T.C. 656
PartiesTATE & LYLE, INC. and Subsidiaries, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court


Dan M. Burt, Henry B. Miller, David G. Tripp, and James R. Hagerty, for petitioner.

Darrell C. Weaver, for respondent.

P is an affiliated group of corporations that filed consolidated U.S. Corporation Income Tax Returns. TLI and RSI are members of P. TLI and RSI accrued interest payable to their foreign parent corporation, PLC, and P deducted such interest in its consolidated returns. Pursuant to the U.S.–U.K. Income Tax Treaty, the interest payable to PLC was exempt from tax and not includable in PLC's gross income for U.S. tax purposes. R disallowed P's accrued interest expense deductions on the grounds that sec. 267(a)(2) and (3), I.R.C., and sec. 1.267(a)–3, Income Tax Regs., require that the interest be deducted in the period in which it was actually paid.

Held : Sec. 267(a)(3), I.R.C., authorizes the issuance of regulations to apply the matching principle of sec. 267(a)(2), I.R.C., in cases where the person to whom the payment to be made is not a U.S. person. Pursuant to the matching principle of sec. 267(a)(2), I.R.C., an accrual basis taxpayer is not entitled to deduct accrued interest if the accrued interest is payable to a related person and, because of the payee's method of accounting, the item is not currently includable in the payee's gross income. Here, the accrued interest is not includable in PLC's gross income because it is exempt from U.S. tax pursuant to Treaty rather than because of PLC's method of accounting. To the extent sec. 1.267(a)–3, Income Tax Regs., requires P to deduct interest payable to PLC using the cash method, it is invalid because it does not apply the matching principle of sec. 267(a)(2), I.R.C.

Held, further, Even if the provisions of sec. 1.267(a)–3, Income Tax Regs., were found to be within the broad regulatory authority granted by sec. 267(a)(3), I.R.C., the retroactive application of the regulations from their issue date on Dec. 31, 1992, to P's taxable years ended Sept. 29, 1985, Sept. 28, 1986, and Sept. 26, 1987, violates the Due Process Clause. See United States v. Carlton, 512 U.S. 26, 114 S.Ct. 2018 (1994). Accordingly, P is not required to defer its interest deduction until paid.


RUWE, Judge:

Respondent determined deficiencies in petitioner's Federal income taxes and additions to tax as follows:

                ¦Additions  ¦          ¦           ¦                                ¦         ¦
                ¦to Tax     ¦          ¦           ¦                                ¦         ¦
                ¦FYE        ¦Deficiency¦Sec. 6653  ¦Sec. 6653(a)(2)                 ¦Sec. 6661¦
                ¦           ¦          ¦(a)(1)     ¦                                ¦(a)      ¦
                ¦9/29/85    ¦$1,244,862¦$62,243    ¦50 percent of the interest due  ¦$311,215 ¦
                ¦           ¦          ¦           ¦on $1,244,862                   ¦         ¦
                ¦           ¦          ¦           ¦                                ¦         ¦
                to Tax
                FYE         Deficiency Sec. 6653(a)  Sec. 6653(a)(1)(B)               Sec. 6661
                                       (1)(A)                                         (a)
                9/28/86     $3,437,849 $171,892      50 percent of the interest due   $ 859,462
                                                     on $3,437,849
                9/26/87     5,130,100  256,505       50 percent of the interest due   1,282,525
                                                     on $5,130,100

The sole issue for decision is whether petitioner may deduct interest owed to its foreign parent in the tax year in which it was accrued, or whether section 267 1 requires that the deduction be deferred until the interest is actually paid.2

The parties submitted this case fully stipulated. The stipulation of facts and attached exhibits, first supplemental stipulation of facts, settlement stipulation, and first supplemental settlement stipulation are incorporated herein by this reference.


Petitioner is an affiliated group of corporations that timely filed consolidated U.S. Corporation Income Tax Returns for the periods at issue. Tate & Lyle, Inc. (TLI), is the common parent of the affiliated group. TLI is incorporated in, and has its principal office in, Delaware. Refined Sugars, Inc. (RSI), is one of the members of petitioner's affiliated group.

During the periods at issue, Tate & Lyle plc (PLC) was a publicly traded United Kingdom corporation and was the parent corporation of the worldwide group of Tate & Lyle companies. PLC indirectly owned 100 percent of TLI and RSI. PLC, TLI, and RSI were members of the same controlled group of corporations as defined in section 267(f).

TLI and RSI were U.S. residents, and PLC was a United Kingdom resident, as defined in the Convention for the Avoidance of Double Taxation, Dec. 31, 1975, U.S.–U.K., 31 U.S.T. 5668 (Treaty). PLC, TLI, and RSI were entitled to all the benefits of the Treaty. At no time during the periods at issue did PLC maintain a permanent establishment or engage in a trade or business in the United States.

PLC made interest-bearing loans to TLI and RSI. RSI borrowed $21 million on April 4, 1985, from PLC for the purpose of acquiring the assets of Great Western Sugar Co. TLI borrowed $27 million on September 30, 1985, from PLC for the purpose of acquiring Vigortone Pacific Molasses Co. Additionally, PLC made short-term loans to TLI and RSI. The interest PLC received from TLI and RSI was U.S.-source income that was not effectively connected with PLC's conduct of a trade or business in the United States. The interest PLC received was exempt from taxation in the United States under Article 11(1) of the Treaty, 31 U.S.T. 5680.

For financial reporting purposes, PLC accrued the interest receivable from TLI and RSI. As required under the income tax laws of the United Kingdom during the periods at issue, PLC reported interest income from TLI and RSI when it was actually received. In 1993, the income tax laws of the United Kingdom were changed, providing that interest income received from foreign sources is subject to tax when the interest accrues rather than when it is received.

In accordance with their methods of accounting, TLI and RSI accrued the interest due on the loans from PLC and charged the accrued interest to an account called “Accrued Interest Payable”. In the taxable periods corresponding to the periods that TLI and RSI accrued the interest, petitioner deducted the accrued interest on its consolidated tax returns. TLI and RSI paid interest to PLC during the tax period following the accrual.3

Respondent disallowed the accrued interest expense deductions petitioner claimed on its consolidated returns on the grounds that the interest should have been deducted in the period in which it was actually paid, not in the period in which it was accrued. In the notice of deficiency, respondent computed the adjustment to petitioner's taxable income as follows:

                ¦                               ¦9/30/84 ¦9/29/85  ¦9/28/86  ¦9/26/87  ¦
                ¦Interest accrued               ¦$185,152¦$204,397 ¦$601,883 ¦$681,459 ¦
                ¦Interest paid                  ¦        ¦(185,152)¦(204,397)¦(601,883)¦
                ¦Notice of Deficiency Adjustment¦        ¦$ 19,245 ¦$397,486 ¦$ 79,576 ¦


Section 267 generally requires taxpayers to defer deductions for amounts payable to a related person until the amount is includable in the recipient's gross income.4 The purpose underlying section 267 is to prevent the use of differing methods of reporting income for Federal tax purposes in order to obtain artificial deductions.

It was recognized that there were instances where an individual on the accrual method became indebted to a creditor with whom he enjoyed a special relationship, such as a member of his family, or to a corporation he controlled, and his creditor reported income on the cash method. Thereafter, as interest became due on the debt, the debtor on the accrual method reported the interest as a deduction for income tax purposes, but he did not make any actual payment to his creditor. Since the creditor was on the cash method, he reported no income. The debtor would consequently gain the benefit of a current deduction, whereas the related creditor would defer income recognition until the year of receipt of actual payment. Sometimes the sum involved would escape income taxation altogether because the payment was timed to a year when the creditor had offsetting losses. Metzger Trust v. Commissioner, 76 T.C. 42, 75–76 (1981), affd. 693 F.2d 459 (5th Cir.1982); fn. ref. omitted.]

The specific matching provisions of section 267 are in subsection (a)(2) which provides:

(2) Matching of deduction and payee income item in the case of expenses and interest.—If—

(A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and

(B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b),

then any deduction allowable under this...

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