Thomas Intern. Ltd. v. U.S.

• Decision Date: 18 September 1985
• Docket Number: No. 85-870,85-870
• Citation: 773 F.2d 300
• Parties: -5867, 85-2 USTC P 9686 THOMAS INTERNATIONAL LIMITED, Appellee, v. The UNITED STATES, Appellant. Appeal
• Court: U.S. Court of Appeals — Federal Circuit

Page 300

773 F.2d 300

56 A.F.T.R.2d 85-5867, 85-2 USTC P 9686

THOMAS INTERNATIONAL LIMITED, Appellee, v. The UNITED STATES, Appellant.

Appeal No. 85-870.

United States Court of Appeals, Federal Circuit.

Sept. 18, 1985.

David Carmack, Tax Div., Dept. of Justice, Washington, D.C., argued, for appellant. With him on brief were Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup and Mary L. Fahey.

Michael D. Gunter, Winston-Salem, N.C., argued, for appellee. William C. Raper and Alice M. Pettey, Womble, Carlyle, Sandridge and Rice, Winston-Salem, N.C., of counsel.

Before FRIEDMAN, Circuit Judge, SKELTON, Senior Circuit Judge, and BISSELL, Circuit Judge.

FRIEDMAN, Circuit Judge.

This is an appeal by the United States from a judgment of the United States Claims Court granting summary judgment to the appellee taxpayer in its tax refund suit. The court held invalid, as unauthorized by the governing statute, a Treasury Regulation pursuant to which the Commissioner of Internal Revenue had denied the appellee the special tax treatment available to a domestic international sales corporation (DISC) that meets specified statutory criteria. We uphold the regulation, reverse the judgment of the Claims Court, and remand the case with instructions to grant the government's motion for summary judgment and to dismiss the suit.

I

A. The DISC provisions of the Internal Revenue Code of 1954, 26 U.S.C. Secs. 991-995 (1976) were added to the Code in 1971. Revenue Act of 1971, Pub.L. No. 92-178, Title V, 85 Stat. 535. Their purpose was to provide tax incentives for United States firms to increase their exports and to remove the previous tax disadvantage of firms engaged in export activities through domestic corporations instead of through foreign subsidiaries. See H.R.Rep. No. 533, 92d Cong., 1st Sess. 58, reprinted in 1971 U.S.Code Cong. & Ad.News 1825, 1872; S.Rep. No. 437, 92d Cong., 1st Sess., reprinted in 1971 U.S.Code Cong. & Ad.News 1918. The basic scheme allows a domestic production company to establish a DISC to handle its export sales and leases. The DISC may be no more than a shell corporation, which performs no functions other than to receive commissions on foreign sales made by its parent.

The DISC is not subject to federal income tax on its "earnings." Instead, part of the DISC's earnings are taxed to its shareholder(s) as constructive dividends and the remainder is taxed only when actually distributed. The exempted earnings must be reinvested in export activities. See generally B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders p 17.14 (4th ed. 1979).

To insure that these tax-deferred profits actually are used for export activities and are not diverted to either production for the domestic market or for manufacturing overseas, Congress provided strict requirements for qualification as a DISC. A corporation that elects DISC treatment must satisfy the income and assets tests set forth in section 992(a)(1).

At least 95 percent of a DISC's gross receipts must consist of "qualified export receipts," which section 993(a)(1) defines as receipts derived from the sale or lease of export property for use outside the United States and from related services. Similarly, at least 95 percent of a DISC's assets must consist of "qualified export assets" which section 993(b) defines as including "accounts receivable and evidences of indebtedness which arise by reason of [specified] transactions of such corporations" that relate to export activities and generate qualified export receipts. The failure to meet either the income or the assets test results in the corporation's loss of DISC status and the recapture of the previously deferred income. Sec. 995(b)(2).

A key element of the DISC scheme is the "producer's loan" provisions of section 993(d). By means of such loans a DISC may make its tax-deferred earnings available to the parent corporation for reinvestment in export activity without jeopardizing its DISC status, since producer's loans qualify as export assets. Section 993(d) The implementing Treasury Regulations provide that the commissions a DISC receives from a related supplier may be treated as qualified export assets, but only if paid within 60 days of the close of the DISC's taxable year. Section 1.993-2(d)(2) provides in pertinent part:

                provides detailed and complex requirements for producer's loans to insure that the DISC's tax-deferred earnings are used only in the parent corporation's export activities.   See CWT Farms, Inc. v. Comm'r, 755 F.2d 790 (11th Cir.1985)
                

If a DISC acts as commission agent for a principal in a transaction ... which results in qualified export receipts for the DISC, and if an account receivable or evidence of indebtedness held by the DISC and representing the commission payable to the DISC as a result of the transaction arises ..., such account receivable or evidence of indebtedness shall be treated as a ... [qualified export asset]. If, however, the principal is a related supplier (as defined in Sec. 1.994-1(a)(3)) with respect to the DISC, such account receivable or evidence of indebtedness will not be treated as a ... [qualified export asset] unless it is payable and paid in a time and manner which satisfy the requirements of Sec. 1.994-1(e)(3)....

Section 1.994-1(e)(3) in turn provides:

The amount of ... a sales commission (or reasonable estimate thereof) actually charged by a DISC to a related supplier ... must be paid no later than 60 days following the close of the taxable year of the DISC during which the transaction occurred.

The validity of this 60-day payment requirement in the Regulations is the issue in this case.

B. The relevant facts of this case, set forth in greater detail in the Claims Court's opinion, 6 Cl.Ct. 414 (1984), are not in dispute. The appellee Thomas International Limited (Thomas), a wholly owned subsidiary of Thomas Built Buses, Inc. (Thomas Buses), was organized as a commission DISC. Thomas accrued commissions on all of Thomas Buses' export sales. For the taxable years ending March 31, 1977 and 1978, Thomas' respective commissions were $708,231 and $329,057, which it entered as accounts receivable on its books. Thomas Buses did not issue checks to Thomas for the commissions until December 15, 1977 and June 1, 1978, respectively. This was 8 1/2 months after the close of Thomas' 1977 taxable year and 62 days after the close of its 1978 taxable year. Since Thomas claimed qualification as a DISC, it paid no taxes for either year.

The Internal Revenue Service assessed deficiencies on Thomas. It ruled that Thomas did not qualify as a DISC for those taxable years because Thomas had not met the qualified export assets test of section 992(a)(1)(B). The Service concluded that the accrued commissions were not qualified export assets because they were not paid to Thomas within 60 days after the close of each taxable year, as Treasury Regulation Sec. 1.993-2(d)(2) required.

Thomas paid the deficiency, and when its refund claim was disallowed, filed the present suit in the Claims Court. On cross-motions for summary judgment the Claims Court granted Thomas' and denied the government's motion. The court held that the 60-day payment requirement for commissions receivable in regulation 1.993-2(d)(2) was unauthorized by, and in fact contrary to, the DISC statute. Since the United States conceded it had no other defense on the merits, the court concluded that Thomas was entitled to judgment as a matter of law.

The court ruled that in light of the entire DISC statute, the term "accounts receivable ... which arise by reason of [export] transactions of such corporation" unambiguously includes commissions receivable. It reasoned that Congress intended to allow a DISC to operate as a commission agent as well as a reseller of goods and that most commission DISCs could not meet the 95 percent export assets test if its commissions receivable were excluded. The court stated that "even if there were an ambiguity with respect to whether or not the accounts receivable which arise by sales in The court then held that the regulation was not sustainable as a reasonable means of preventing the circumvention of the "producer's loan" provisions. It stated that the Treasury may not add requirements which Congress failed to adopt "to close a loophole" unless Congress delegated specific legislative or rule-making authority to the Treasury. The court found that the 60-day payment requirement

                which the DISC is merely the agent, it has been resolved by provisions of Treasury Regulation Sec. 1.993-2(d)(2) other than the 60-day payment requirement."    6 Cl.Ct. at 419.  The court concluded that the 60-day payment rule could not "be deemed to be merely an interpretation of any statutory phrase but is an additional requirement superimposed thereon for another purpose."    Id
                

attempts to resolve a question of substance versus form by making conclusive against the taxpayer what would otherwise be only a single factor in that factual inquiry. It denies the taxpayer the opportunity to prove that the funds which could have been used to pay the commissions were in fact used by the related supplier as export assets for purposes consistent with those permissible for producer's loans. And it also makes irrelevant any proof that the failure of the agent to receive payment of the commissions within the 60 days may have been for bona fide reasons, such as hardship, inadvertence, failure of the customer to make prompt payment, uncertainty as to amount or difficulty in computation, rather than as a device to circumvent the producer's loan restrictions."

Id. at 420.

II

The regulations for section 993 were promulgated pursuant to the Treasury's general authority under section 7805(a) to "prescribe all needful rules and regulations for the enforcement of this title." See 37 Fed.Reg. 20853 (1972). They are thus entitled to less deference than regulations issued...