Union Carbide Corp. v. United States

• Decision Date: 12 December 1979
• Docket Number: No. 180-78.,180-78.
• Citation: 612 F.2d 558
• Parties: UNION CARBIDE CORPORATION v. The UNITED STATES.
• Court: U.S. Claims Court

612 F.2d 558

UNION CARBIDE CORPORATION v. The UNITED STATES.

No. 180-78.

United State Court of Claims.

December 12, 1979.

Raphael Sherfy, Washington, D. C., for plaintiff. Robert D. Heyde, Washington, D. C., atty. of record. William M. Bellamy, Jr., New York City, John F. Mooney, Stamford, Conn., Fred W. Peel, Jr., Little Rock, Ark., Miller & Chevalier, Washington, D. C., of counsel.

Marc M. Levey, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant. Theodore D. Peyser, Jr., Bruce W. Reynolds, Washington, D. C., of counsel.

Before DAVIS, KUNZIG and BENNETT, Judges.

PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

BENNETT, Judge:

The plaintiff, Union Carbide Corporation, sues for a refund of federal income taxes and interest paid for the calendar year 1967.¹ Plaintiff's recovery depends upon the proper method to be used in computing the reduction in the foreign tax credit required by I.R.C. § 1503(b)(1). The case is before the court on plaintiff's motion for partial summary judgment² and defendant's cross-motion for summary judgment. We hold for plaintiff.

The basic facts of the case are not in dispute and may be simply stated. Plaintiff is the parent of an affiliated group of corporations which in the year in question filed a consolidated federal income tax return under I.R.C. §§ 1501-1563. Plaintiff elected to have its foreign tax credit subject to the overall limitation under I.R.C. § 904(a)(2), 74 Stat. 1010 (1960) (now I.R.C. § 904(a)).³ The affiliated group contained two Western Hemisphere trade corporations (WHTCs), both of which in 1967 had gross income in excess of deductions. The group also contained several other corporations which were not WHTCs. Some of these non-WHTCs sustained net operating losses in 1967.

On its 1967 return plaintiff calculated the deduction allowed under I.R.C. § 922 to WHTCs in accordance with Treas.Reg. § 1.1502-25(c) (1966). Plaintiff did not, however, use the method prescribed by the regulation to determine the amount by which its foreign tax credit should be reduced under I.R.C. § 1503(b)(1). On audit the Internal Revenue Service (Service) determined a deficiency for 1967 on the basis that the regulation also applies to computations under I.R.C. § 1503(b)(1). On July 6, 1971, plaintiff paid the additional taxes asserted by the Service. On February 26, 1973, the National Office of the Service issued a technical advice memorandum with respect to plaintiff's 1967 return, which stated that the rules of Treas.Reg. § 1.1502-25(c) should not be applied in computing the reduction under I.R.C. § 1503(b)(1) of the foreign taxes paid by plaintiff's WHTC affiliates. Shortly thereafter, on April 23, 1973, plaintiff timely filed a claim for refund. No formal notice of disallowance was ever sent to plaintiff, and after the expiration of more than 6 months plaintiff filed the present suit.

In its motion for partial summary judgment, plaintiff contends that a refund should be made because Treas.Reg. § 1.1502-25(c) is invalid or, alternatively, because the regulation, even if valid, is inapplicable to I.R.C. § 1503(b)(1). Defendant disputes both contentions and further argues that plaintiff may not now question the validity of the regulation since plaintiff complied with the regulation in computing its consolidated section 922 deduction.

In contrast to the simple facts of the case, the Internal Revenue Code provisions and Treasury regulations pertaining to the case are quite complex.

Section 922 provides a WHTC with a special deduction equal to a fraction of its taxable income. In 1967 this fraction was 29.167 percent,⁴ making WHTCs taxable at a rate of approximately 34 percent of taxable income prior to the section 922 deduction (ignoring the effect of the surtax exemption). Unlike some types of corporations with special tax status, a WHTC is not excluded from the privilege of filing consolidated returns with other members of its affiliated group.⁵ It is therefore necessary to integrate the section 922 deduction into the consolidated return framework. Treas. Reg. § 1.1502-25(a) specifies the formula by which the consolidated section 922 deduction is to be determined. This deduction is computed by multiplying the fraction in section 922(2)⁶ by "that portion of the consolidated taxable income attributable to those members of the group which are Western Hemisphere trade corporations." Treas.Reg. § 1.1502-25(c) then specifies the method for determining such portion of consolidated taxable income.⁷

No mention is made in Treas.Reg. § 1.1502-25(c) as to whether it also applies to computations under section 1503(b)(1). That section requires the computation of the federal income tax due with respect to "the portion of the consolidated taxable income attributable to such WHTC corporations." The similarity of the language in section 1503(b)(1) and Treas.Reg. § 1.1502-25(c) lends at least surface plausibility to defendant's argument that consolidated taxable income attributable to WHTCs should be computed by the same method under each provision. Before this argument and the validity of the regulation can be evaluated, it is necessary to consider the purpose and operation of section 1503(b)(1).

Section 1503(b)(1) was enacted as part of Pub.L. No. 86-780, 74 Stat. 1010 (1960).⁸ The primary purpose of this Act was to amend I.R.C. § 904 to permit taxpayers to elect an overall limitation on the foreign tax credit.⁹ Some form of limitation on the foreign tax credit is necessary to prevent foreign taxes, which might be payable at a higher rate than the United States income tax, from offsetting United States taxes on domestic income. Immediately prior to the Act, there was only the per country limitation under which the available credit was computed separately based on the income from and taxes paid to each foreign country.¹⁰ The new elective overall limitation permitted taxpayers to treat foreign taxes and foreign source income collectively.¹¹ Thus, if the election was made, foreign taxes of one country in excess of the applicable United States tax rate could be used as a credit against the United States taxes on foreign source income from another country which imposed taxes at a rate below that in the United States.

In enacting the elective overall limitation, Congress realized that the election could result in a double tax benefit where a consolidated return is filed by an affiliated group containing one or more WHTCs. If a WHTC paid foreign taxes in excess of the effective United States rate on WHTC income (38 percent when section 1503(b)(1) was enacted, 34 percent in the 1967 tax year involved here), the excess foreign taxes could be used as a credit against the United States taxes on the foreign source income of other non-WHTC members of the affiliated group. In order to prevent the lower effective United States tax rate on WHTC income from also providing a foreign tax credit bonus, section 1503(b)(1) was enacted at the same time as the change in the foreign tax credit limitation.¹² Section 1503(b)(1) provides as follows:

Sec. 1503. Computation and payment of tax.

(b) Special rule for application of foreign tax credit when overall limitation applies.—

(1) In general.—If the affiliated group includes one or more Western Hemisphere trade corporations (as defined in section 921), and if for the taxable year an election under section 904(b)(1) (relating to election of overall limitation on foreign tax credit) is in effect, then the amount of taxes paid or accrued to foreign countries and possessions of the United States by such Western Hemisphere trade corporations which may be taken into account for purposes of section 901 shall be reduced by the amount (if any) by which—

(A) the amount of such taxes (or, if smaller, the amount of the tax which would be computed under subsection (a), if such corporations were not Western Hemisphere trade corporations, with respect to the portion of the consolidated taxable income attributable to such corporations), exceeds

(B) the amount of the tax computed under subsection (a) with respect to the portion of the consolidated taxable income attributable to such corporations.

Under section 1503(b)(1) the foreign tax credit is reduced by the amount by which foreign taxes of a WHTC exceed the 34 percent effective United States rate, but only to the extent that such excess is less than the 48 percent generally effective United States tax rate. Thus, the maximum foreign tax credit reduction is equal to 14 percent of consolidated taxable income attributable to WHTCs, the same amount as the total tax savings resulting from WHTC status. Although the savings from the foreign tax credit may exceed 14 percent, there is no double benefit beyond this point.

As indicated above, Treas.Reg. § 1.1502-25(c) specifies the method by which consolidated taxable income attributable to WHTCs is to be determined for purposes of the consolidated section 922 deduction. The regulation provides that consolidated taxable income attributable to WHTCs is obtained by multiplying consolidated taxable income (computed without regard to the section 922 deduction) by the following fraction:

sum of the taxable incomes of all WHTC members sum of the taxable incomes of all members

The last sentence of Treas.Reg. § 1.1502-25(c) provides that, if a member has an excess of deductions over gross income, then that member's taxable income shall be treated as zero in computing the above fraction. Thus, the regulation requires that net operating losses suffered by any member should be excluded from both the numerator and denominator of the above fraction (hereinafter called the fractional method without losses).

Plaintiff urges that the last sentence of the regulation is invalid. In plaintiff's view, the net operating losses of a member should be included in both the numerator and denominator of...