American Air Liquide, Inc. and Subsidiaries v. Commissioner , 116 T.C. No. 3 ( 2001 )

116 T.C. No. 3
UNITED STATES TAX COURT
AMERICAN AIR LIQUIDE, INC. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20381-98. Filed January 16, 2001.
P is the parent of a consolidated group that
includes L. P’s ultimate parent is L’Air, a French
corporation. L’Air pays royalties to P and L under
license agreements for intellectual property owned by P
and L and used by L’Air outside the United States.
P treated the royalty income as sec. 904(d)(1)(I),
I.R.C., general limitation income, relying on the
“reserved” paragraph in sec. 1.904-5(i)(3), Income Tax
Regs.; Article 24(3) of the U.S.-France Treaty, the
capital nondiscrimination provision; and written
statements of Treasury officials.
R determined the royalty income is sec.
904(d)(1)(A), I.R.C., passive income for the purpose of
calculating P’s foreign tax credit.
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Held: The royalty income is passive income for the
purpose of calculating P’s foreign tax credit. Neither
alone nor in combination did the “reserved” paragraph
in sec. 1.904-5(i)(3), Income Tax Regs., Article 24(3)
of the U.S.-France Treaty, or written statements of
Treasury officials constitute an exception to sec.
904(d) entitling P to characterize the royalty income
as general limitation income.
E.A. Dominianni and Edmund S. Cohen, for petitioner.
Steven R. Winningham, Lydia A. Branche, and Rebecca I.
Rosenberg, for respondent.
OPINION
LARO, Judge: Respondent determined deficiencies in
petitioner’s Federal income taxes of $320,351, $1,083,746, and
$942,456 for 1989, 1990, and 1991,1 respectively.
This matter is before the Court on cross-motions for
judgment on the pleadings under Rule 120(a).2 In support of its
motion, petitioner attached exhibits to its response. These
exhibits require us to consider matters outside the pleadings,
and as a consequence we have recharacterized the motions as
cross-motions for summary judgment under Rule 121. See Rule
120(b).
1
In the petition, petitioner concedes that $160,196,
$333,746, and $222,456 of the amounts determined as deficiencies
in 1989, 1990, and 1991, respectively, are not in dispute.
2
Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise indicated, section references and
references to the Code are to the Internal Revenue Code in effect
for the years in issue.
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We must decide whether royalties received by petitioner, a
domestic corporation, from its foreign parent should be
classified as section 904(d)(1)(A) passive income or as section
904(d)(1)(I) general limitation income for purposes of
determining petitioner’s foreign tax credit. We hold that they
are section 904(d)(1)(A) passive income.
Background
Petitioner’s principal place of business was located in
Walnut Creek, California, when the petition was filed. American
Air Liquide, Inc. (AAL), is the common parent of a group of
corporations that filed consolidated returns in the years in
issue. Liquid Air Corp. (LAC) is a member of AAL’s affiliated
group.
L’Air Liquide, S.A. (L’Air), is a French corporation that is
the ultimate parent of petitioner. L’Air produces, sells, and
distributes industrial gases, related equipment and services, and
welding products throughout the world through its own operations
in France and through its French and non-French subsidiaries.
In 1986, AAL acquired the LAC research facilities and rights
to all technical information developed, or being developed, by
LAC. Under various license agreements among AAL, LAC, and L’Air,
AAL and LAC received royalties of $4,775,000, $5 million, and
$4,800,000 from L’Air in 1989, 1990, and 1991, respectively. The
royalties were paid by L’Air for nonexclusive, irrevocable, and
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perpetual licenses to exploit, outside the United States, certain
technical information developed (or to be developed) at LAC’s
research facility and certain improvements made (or to be made)
to certain patent rights licensed to LAC by L’Air. On its tax
returns for the years in issue, petitioner characterized the
royalties received from L’Air as section 904(d)(1)(I) general
limitation income for foreign tax credit purposes. On
examination, respondent recharacterized the royalties as section
904(d)(1)(A) passive income. The deficiencies are a result of
this recharacterization.
Discussion
A. Whether Summary Judgment Is Appropriate
Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials. See Northern Ind. Pub.
Serv. Co. & Subs. v. Commissioner, 101 T.C. 294, 295 (1993);
Florida Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988);
Shiosaki v. Commissioner, 61 T.C. 861, 862 (1974). Summary
judgment is appropriate where there is no genuine issue as to any
material fact and a decision may be rendered as a matter of law.
See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518,
520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Jacklin v.
Commissioner, 79 T.C. 340, 344 (1982). In deciding whether to
grant summary judgment, the Court must consider the factual
materials and inferences drawn from them in the light most
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favorable to the nonmoving party. See Bond v. Commissioner, 100
T.C. 32, 36 (1993); Naftel v. Commissioner, 85 T.C. 527, 529
(1985).
The parties agree that for the purpose of deciding these
cross-motions there are no genuine issues of material fact and
that the Court may decide the issue as a matter of law. Hence,
this case is ripe for summary judgment.
B. Characterization of Royalty Income
The determination of the proper characterization of the
royalty income requires an analysis of the following provisions:
(1) Section 904, (2) section 1.904-5, Income Tax Regs., and (3)
Article 24(3) of the Convention With Respect to Taxes on Income
and Property, July 28, 1967, U.S.-Fr., T.I.A.S. 6518, as amended
by Supplementary Protocols, Oct. 12, 1970, T.I.A.S. 7270; Nov.
24, 1978, T.I.A.S. 9500; Jan. 17, 1984, T.I.A.S. 11096; and June
16, 1988, T.I.A.S. 11967 (U.S.-France Treaty).
1. Statutory Background
Pursuant to section 904(a), the amount of foreign tax credit
allowable under section 901 may not exceed the same proportion of
the tax against which such credit is claimed which the taxpayer’s
taxable income from sources without the United States bears to
its entire taxable income for the same taxable year. See sec.
904(a). Under section 904, the allowable foreign tax credit is
computed separately for each of the categories or baskets of
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income listed in subparagraphs (A) through (I) of section
904(d)(1).3 We concern ourselves with two of these baskets. The
first, subparagraph (I), is referred to as general limitation
income. The other is subparagraph (A), referred to as passive
income. In pertinent part, section 904(d)(2)(A) defines passive
income as “any income received or accrued by any person which is
of a kind which would be foreign personal holding company income
3
Sec. 904(d)(1) provides:
In general. The provisions of subsections (a), (b), and
(c) and sections 902, 907, and 960 shall be applied
separately with respect to each of the following items
of income:
(A) passive income,
(B) high withholding tax interest,
(C) financial services income,
(D) shipping income,
(E) in the case of a corporation, dividends
from each noncontrolled section 902
corporation,
(F) dividends from a DISC or former DISC (as
defined in section 992(a)) to the extent
such dividends are treated as income
from sources without the United States,
(G) taxable income attributed to foreign
trade income (within the meaning of
section 923(b)),
(H) [certain] distributions from a FSC...,
and
(I) income other than income described in
any of the preceding subparagraphs.
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(as defined in section 954(c)).” Subparagraph (A) of section
954(c)(1) defines “foreign personal holding company income” to
include “Dividends, interest, royalties, rents, and annuities.”
Respondent focuses on the facts that section 904(a)(1)
places passive income into a passive basket and that “royalties”
are specifically referred to in section 954(c)(1) as a type of
passive income. Petitioner expands on this focus by reference to
section 904(d)(3)(C) and section 1.904-5, Income Tax Regs., which
together apply a look-through rule in the case of controlled
foreign corporations and other entities. Section 904(d)(3)(C)
provides:
Any interest, rent, or royalty which is received or accrued
from a controlled foreign corporation in which the taxpayer
is a United States shareholder shall be treated as income in
a separate category to the extent it is allocable (under
regulations prescribed by the Secretary) to income of the
controlled foreign corporation.
Section 1.904-5(b), Income Tax Regs., provides:
In general. Except as otherwise provided in section
904(d)(3) and this section, dividends, interest, rents,
and royalties received or accrued by a taxpayer from a
controlled foreign corporation in which the taxpayer is
a United States shareholder shall be treated as general
limitation income.
Section 1.904-5(i)(3), Income Tax Regs., is also relevant to
petitioner’s analysis. It is entitled “Special rule for payments
from foreign parents to domestic subsidiaries” and contains no
text. The Secretary explicitly “[RESERVED]” the rules under that
provision during the years in issue. In 1992 the Secretary
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promulgated new final regulations which omitted the reserved
paragraph. The preamble to the new final regulations states that
the Commissioner had decided not to adopt rules which look
through payments from foreign parents to U.S. subsidiaries
because of administrative and policy concerns. The preamble
states:
To apply the look-through rules, the Service needs
complete information concerning the foreign
corporation’s income and expenses. The Service may not
be able to obtain all of the necessary information from
a foreign parent corporation and to audit it. In
addition, the payments generally would be deductible
from taxable income of the payor that is entirely
outside the jurisdiction of the United States
(including subpart F) and, therefore, do not give rise
to the same concerns involved in other look-through
cases. [T.D. 8412, 1992-1 C.B. 273 (preamble to the
1992 final regulations).]
Petitioner further relies on the U.S.-France Treaty and more
specifically the nondiscrimination provision embodied in Article
24(3), which provides:
A corporation of a Contracting State, the capital of
which is wholly or partly owned or controlled, directly
or indirectly, by one or more residents of the other
Contracting State, shall not be subjected in the first-
mentioned Contracting State to any taxation or any
requirement connected therewith which is other or more
burdensome than the taxation and connected requirements
to which a corporation of that first-mentioned
Contracting State carrying on the same activities, the
capital of which is wholly owned by one or more
residents of that first-mentioned State, is or may be
subjected.
Unless there is a reason to disregard the general rule of
section 904(d), petitioner’s royalties from L’Air should be
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characterized as passive income for the purpose of computing
petitioner’s foreign tax credit limitation.
2. Petitioner’s Position That Royalties Received Are
General Limitation Income
Petitioner makes three arguments in support of its position
that the royalties received should not be treated as passive
income. Firstly, petitioner argues, treating royalties received
from L’Air as passive basket income impermissibly discriminates
against petitioner in violation of the nondiscrimination article
of the U.S.-France Treaty. Secondly, petitioner argues, the
“reserved” paragraph in section 1.904-5(i)(3) Income Tax Regs.,
when read in the relevant regulatory context and in light of
public written statements, mandates that royalties such as those
at issue be categorized as general limitation income. Thirdly,
petitioner argues, senior Treasury officials have stated clearly
in writing that the Department of the Treasury will shortly issue
regulations under which the subject royalties are categorized as
general limitation income. To date, no such retroactive
regulations have been issued. However, on January 3, 2001, the
Department of the Treasury published proposed rules that, among
other things, “propose to amend prospectively § 1.904-4(b)(2)”,
Income Tax Regs. 66 Fed. Reg. 319, 320 (emphasis added). The
supplementary information accompanying the proposed regulation
states:
Treasury and the IRS have consistently declined to extend
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look-through treatment to payments from foreign non-
controlled payors. See TD 8412 (1992-1 C.B. 271, 273).
Treasury and the IRS continue to believe that the nature of
the income earned by a foreign non-controlled payor from the
use of the licensed property should not determine whether a
rent or royalty payment constitutes income from the active
conduct of a trade or business of the recipient. [Id.]
The supplementary information accompanying the proposed
regulation strongly supports respondent’s position in the instant
case. Further, we find no support for petitioner’s arguments
contained in the proposed regulations.
C. Analysis
1. Interaction of Code and U.S.-France Treaty Provision
Under the U.S. Constitution, treaties are given equal status
with laws passed by Congress. See U.S. Const., art. VI, sec. 1,
cl. 2. A treaty is to be liberally construed to give effect to
the purpose which animates it. See United States v. Stuart, 489
U.S. 353, 368 (1989); Bacardi Corp. of Am. v. Domenech, 311 U.S.
150, 163 (1940). When a provision of a treaty fairly admits of
two constructions, one restricting, the other enlarging, rights
which may be claimed under it, the more liberal interpretation is
to be preferred. See United States v. Stuart, supra at 368;
Bacardi Corp. of Am. v. Domenech, supra; Samann v. Commissioner,
36 T.C. 1011, 1014-1015 (1961), affd. 313 F.2d 461 (4th Cir.
1963). In construing a treaty, the Court gives the language its
ordinary meaning in the context of the treaty, unless a more
restricted sense is clearly intended. See De Geofroy v. Riggs,
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133 U.S. 258, 271 (1890). When a treaty and a statute relate to
the same subject, courts attempt to construe them so as to give
effect to both, see Whitney v. Robertson, 124 U.S. 190, 194
(1888), because “the intention to abrogate or modify a treaty is
not to be lightly imputed to the Congress”, Menominee Tribe v.
United States, 391 U.S. 404, 413 (1968) (quoting Pigeon River Co.
v. Cox Co., 291 U.S. 138, 160 (1934)); see also Estate of
Burghardt v. Commissioner, 80 T.C. 705, 713 (1983), affd. without
published opinion 734 F.2d 3 (3d Cir. 1984).
Petitioner argues that the characterization of royalty
income under section 904 must be identical for royalties received
by a U.S. subsidiary from a foreign parent corporation and
royalties received by a domestic corporation from a controlled
foreign corporation. Petitioner argues that to not characterize
its royalty income from L’Air as section 904(d)(1)(I) general
limitation income would violate Article 24(3) of the U.S.-France
Treaty. Petitioner cites the deficiency itself as evidence of
the detriment it suffers because respondent treats the royalty
income as passive income rather than general limitation income.
We disagree with petitioner’s analysis. Petitioner’s analysis
ignores the differences in the tax treatment, imposed by subpart
F, sections 951 to 964, of the Code, and consequently the
circumstances of the respective taxpayers mentioned.
Article 24(3), which corresponds to Article 24(5) of the
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current OECD model convention, is a means “to ensure equal
treatment for taxpayers residing in the same State.” I Model Tax
Convention On Income and On Capital, Article 24, par. 5, 57 (OECD
Nov. 1977). Petitioner is a domestic corporation, and the tax
treatment of its foreign source royalty income is determined in
exactly the same manner as for any other domestic corporation
receiving royalty income from a noncontrolled foreign
corporation. Petitioner has received equal treatment with all
other similarly situated taxpayers residing in the United States.
The fact that petitioner’s ultimate parent is a French
corporation plays no part in determining the characterization of
petitioner’s royalty income. Consequently, we do not find any
basis for petitioner’s assertion that respondent’s alleged
failure to characterize petitioner’s royalty income as section
904(d)(1)(I) general limitation income contravenes Article 24(3)
of the U.S.-France Treaty.
2. The “Reserved” Paragraph and Treasury Representations
For convenience, we will examine petitioner’s second and
third arguments together. Petitioner’s reliance on the
“reserved” paragraph in section 1.904-5(i)(3), Income Tax Regs.,
is also misplaced. In Connecticut Gen. Life Ins. Co. v.
Commissioner, 109 T.C. 100, 110 (1997), affd. 177 F.3d 136 (3d
Cir. 1999), we held in similar circumstances that a reserved
paragraph in a regulation “simply reserves a space for
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regulations that may be promulgated at a later date and that may
provide a special rule”. (Emphasis added). The Court of Appeals
for the Third Circuit when discussing the same reserved provision
stated:
the Office of the Federal Register, Document Drafting
Handbook (1991), * * * describes “reserved” as “a term
used to maintain the continuity of codification in the
CFR” or “to indicate where future text will be added.”
Id. at 27. We find nothing in the precedent that * *
*[the taxpayer] cites to preclude the Commissioner from
using the term “reserved” in accordance with the
Document Drafting Handbook, rather than to connote the
absence of a substantive rule. [Connecticut Gen. Life
Ins. Co. v. Commissioner, 177 F.3d at 145.]
We see no reason to take a different view in this case. The
reserved paragraph as a general rule only indicates a place mark
in the regulation that is reserved to preserve continuity of
codification where the Department of the Treasury is considering
its position.
Petitioner, in its memorandum of law in support, seeks to
distinguish Connecticut Gen. Life Ins. Co. v. Commissioner,
supra, on the basis that unlike the facts in that case, in the
instant case, “the meaning ascribed to the Reserved Paragraph by
the Petitioner is unambiguously supported by numerous public
written statements of similarly affected taxpayers, and is not
contradicted in any of numerous public statements made by senior
Treasury Department and other governmental officials addressing
the issue”. Petitioner attached to its response to respondent’s
motion for judgment on the pleadings exhibits A through H. These
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exhibits contain correspondence on the Department of the Treasury
letterhead, and correspondence to the Department of the Treasury.
Taken together, and viewed in the light most favorable to
petitioner, we are unable to conclude that they represent
anything more than confirmation that the Department of the
Treasury was considering whether to extend look-through treatment
to domestic subsidiaries with foreign parents.
Accordingly,
An appropriate order will be
entered granting respondent’s
motion for summary judgment and
denying petitioner’s motion for
summary judgment. Decision will be
entered for respondent.