F. W. Woolworth Co. v. Commissioner , 54 T.C. 1233 ( 1970 )

F. W. Woolworth Co., Petitioner v. Commissioner of Internal Revenue, Respondent

F. W. Woolworth Co. v. Commissioner

Docket Nos. 84442, 91247, 2130-62

United States Tax Court

54 T.C. 1233; 1970 U.S. Tax Ct. LEXIS 118;

June 15, 1970, Filed

---

">*118

Decisions will be entered under Rule 50.

1. Certain taxes paid by petitioner's English subsidiary under Schedule A of the English Income Tax Act of 1952 do not for foreign tax credit purposes qualify as an income tax or a tax paid in lieu of an income tax within the meaning of secs. 901 and 903, I.R.C. 1954.

2. Respondent's allocation of various deduction items to certain foreign-source income in order to reduce petitioner's per country limitation on taxes paid or deemed paid to England, Germany, Puerto Rico, and Cuba, was not required under the provisions of sec. 862(b) and the applicable underlying regulations.

Charles B. McInnis, G. Kibby Munson, Roger H. Munzall, and James J. O'Neil, for the petitioner.

William F. Chapman, for the respondent.

Sterrett, Judge.

---

STERRETT

">*1233 Respondent determined deficiencies in petitioner's income tax for 1957, 1958, and 1959 as follows:

			Increased
Year	Docket	Deficiency	deficiency in	Total
	No.		amended	deficiency
			answer
1957	84442	$ 133,397.54	$ 47,183.98	$ 180,581.52
1958	91247	217,124.05		217,124.05
1959	2130-62	66,981.50	951,687.04	1,018,688.54

The issues are (1) whether the tax paid by petitioner's British subsidiary (F. W. Woolworth & Co., Ltd.) under schedule A of the ">*119 English Income Tax Act, 1952, constitutes an income tax or a tax in lieu of an income tax within the meaning of sections 901, 902, and/or 903 of the ">*1234 Internal Revenue Code of 1954; ¹ and (2) whether for purposes of determining the numerator of the limiting fraction of the per country limitation with respect to foreign taxes paid or deemed paid by petitioner, various deduction items are allocable under section 862(b) and the applicable regulations to certain foreign source income received by the petitioner.

FINDINGS OF FACT

I. General Findings of Fact

Some of the facts were stipulated and they are so found.

F. W. Woolworth Co. (hereinafter called petitioner) is a corporation organized and existing under the laws of the State of New York with its principal office and place of business at 233 Broadway, New York, N.Y. During the years here involved and at all times here pertinent petitioner employed an accrual method of accounting and filed its Federal income tax returns on the basis of a calendar year. Petitioner filed its Federal income tax returns for 1957, 1958, and 1959 with the district ">*120 director of internal revenue, Manhattan District, New York, N.Y.

During the years 1957, 1958, and 1959 and at all times here relevant petitioner was engaged in the direct operation of a chain of variety stories located throughout the United States, Cuba, and Puerto Rico. The number of such variety stores operated by petitioner varied between 2,100 and 2,200 during the years 1957, 1958, and 1959.

During the years here involved petitioner owned 52.7 percent of the common capital stock in which voting power resides (71,145,000 shares out of 135 million shares outstanding) and 140 shares of preferred stock (nonvoting) out of 5 million outstanding of F. W. Woolworth & Co., Ltd. (England), which company operated a chain of approximately 1,100 variety stores throughout the British Isles. During the years here involved petitioner owned 97 percent of the capital stock of F. W. Woolworth Co., G.m.b.H. (Germany), which company operated a chain of variety stores throughout the Republic of West Germany ranging from 75 stores in 1957 to 91 stores in 1959. During the years here involved petitioner owned 100 percent of the capital stock of F. W. Woolworth Co., Ltd. (Canada), which company operated ">*121 approximately 215 variety stores throughout the Dominion of Canada.

Petitioner has a substantial investment in its English and German subsidiaries. Petitioner's balance sheet as of December 31, 1959, shows its investment in the English subsidiary in the amount of $ 30,880,118 and its investment in the German subsidiary in the amount of $ 3,262,291. ">*1235 According to the closing quotation on the London Stock Exchange as of December 31, 1959, the ordinary (common) stock in the English subsidiary held by petitioner had an aggregate market value of $ 680,987,000.

During the years here involved petitioner operated stores in Cuba and Puerto Rico. Such stores were operated by petitioner directly through its New York regional office as branch operations rather than through subsidiary corporations.

Petitioner reported the following amounts of income in its Federal income tax returns for 1957, 1958, and 1959:

	Gross profit	Interest		Net capital
Year	from sales	1income	Rents	gains or ordinary
				2">*122 losses
1957	$ 309,019,925.68	$ 180,824.41	$ 4,046,874.06	$ 157,860.14
1958	316,834,560.32	213,145.75	3,909,021.42	55,389.50
1959	337,247,739.01	321,644.52	3,877,334.88	(385,177.23)

During the years 1957, 1958, and 1959 petitioner received dividends from various sources in the following amounts:

	1957	1958	1959
Domestic sources			$ 68.65
English subsidiary	$ 11,421,251.19	$ 11,498,047.00	13,789,290.31
Canadian subsidiary	2,025,000.00	4,050,000.00
German subsidiary	1,411,537.01	738,045.99	2,685,628.04

After deducting all applicable expenses (including a charge to each Cuban store for a portion of petitioner's executive office expenses allocated on the same basis as to a store in the continental United States), petitioner's branch in Cuba had net earnings for the years 1957 through 1959 as follows: $ 514,997.27 in 1957; $ 467,498.15 in 1958; and $ 851,907.98 in 1959.

After deducting all applicable expenses (including a charge to each Puerto Rican store for a portion of petitioner's executive office expenses allocated on the same basis as to a store in the continental United States), petitioner's branch in Puerto Rico had net earnings for the years 1957 through 1959 as follows: $ 65,860.86 in 1957; $ 172,205.25 in 1958; and $ 272,016.64 in 1959.

During the year 1957 petitioner received other taxable income in the total amount of $ 47,623.57 which it reported in its ">*123 Federal income tax return for that year. Petitioner's total gross income for the years 1957 through 1959, as reported in its Federal income tax returns ">*1236 for those years, was as follows: $ 328,310,896.06 in 1957; $ 337,298,209.98 in 1958; and $ 357,536,528.16 in 1959.

Petitioner paid taxes to the Cuban Government and claimed a credit for such taxes in its Federal income tax returns as follows:

		Credit claimed under
	Total Cuban taxes	sec. 904 limitation
1957	$ 204,317.73	$ 204,317.73
1958	203,578.03	203,578.03
1959	428,546.20	428,546.20

Respondent contended in his amended answers in docket No. 84442 (1957) and docket No. 2130-62 (1959) that the Cuban taxes paid and the credits therefor should be in the following amounts:

		Credit allowed under
	Total Cuban taxes	sec. 904 limitation
1957	$ 204,317.73	$ 204,317.73
1958	216,130.42	216,130.42
1959	428,546.20	415,993.48

Petitioner paid taxes to the Puerto Rican Government and claimed a credit for such taxes in its Federal income tax returns as follows:

	Total Puerto	Credit claimed under
	Rican taxes	sec. 904 limitation
1957	$ 8,754.09	$ 8,754.09
1958	28,647.18	28,647.18
1959	55,569.26	55,569.26

Respondent made a minor adjustment in the taxes paid and credit claimed for 1958, which adjustment ">*124 is not in dispute here.

Petitioner claimed and was allowed a foreign tax credit under section 902 for a portion of the taxes paid by its three foreign subsidiaries (English, German, and Canadian) to the English, German, and Canadian Governments, as well as a credit for taxes withheld at the source on dividends paid to petitioner by its German and Canadian subsidiaries.

Respondent made no adjustment for the years 1957, 1958, and 1959 to petitioner's foreign tax credit with respect to its income from its Canadian subsidiary.

In its Federal income tax returns for the years 1957, 1958, and 1959 petitioner claimed credit for a portion of the income taxes paid by its English subsidiary under schedule D of the British Income Tax Act of 1952 and for a portion of the profits taxes paid by its English subsidiary as follows:

	Total English
	taxes deemed paid	Credit claimed under
	by petitioner	sec. 904 limitation
1957	$ 6,039,577.30	$ 5,928,035.61
1958	6,063,753.66	5,973,885.36
1959	6,781,814.03	6,781,814.03

">*1237 The English taxes deemed paid and the credits for such taxes were allowed in the following amounts by the respondent in his statutory notices of deficiency:

	Total English
	taxes deemed paid	Credit allowed under
	by petitioner	sec. 904 limitation
1957	$ 6,040,508.90	$ 5,918,796.63
1958	5,920,629.97	5,920,629.97
1959	6,698,431.54	6,698,431.54

Respondent ">*125 now contends that the credit allowable to petitioner with respect to English taxes under the section 904 limitation for 1957 is in the amount of $ 5,878,489.31.

In its Federal income tax returns for the years 1957, 1958, and 1959 petitioner claimed credit for German taxes withheld at the source on dividends paid to petitioner by its German subsidiary and for a portion of the German income taxes paid by its German subsidiary as follows:

	Total German taxes
	paid and deemed	Credit claimed under
	paid by petitioner	sec. 904 limitation
1957	$ 856,381.81	$ 732,637.94
1958	451,813.55	383,456.63
1959	2,017,450.40	1,396,240.64

The German taxes paid and deemed paid and the credits therefor were allowed by respondent in his statutory notice of deficiency as follows:

	Total German taxes
	paid and deemed	Credit allowed under
	paid by petitioner	sec. 904 limitation
1957	$ 856,381.81	$ 731,496.08
1958	576,922.68	383,461.78
1959	2,016,990.25	1,396,245.18

Respondent now contends that the German taxes paid and deemed paid by petitioner and the credits therefor should be in the following amounts:

	Total German taxes
	paid and deemed	Credit allowed under
	paid by petitioner	sec. 904 limitation
1957	$ 856,381.81	$ 726,515.11
1958	576,922.68	380,499.38
1959	2,016,990.25	1,385,371.46

II. ">*126 Findings of Fact Relating to Issue of Eligibility for Foreign Tax Credit of Certain Taxes Paid to Great Britain

For many years, including the years here involved, petitioner's English subsidiary has followed the practice, which is almost universally followed by English companies, of paying two dividends on its ordinary (i.e., common) stock out of each year's earnings. The first dividend, termed an interim dividend, is paid at sometime during the year and the second dividend, termed a final dividend, is paid during ">*1238 the early part of the following year. In the case of petitioner's English subsidiary the interim dividend is usually paid during the first or second week of August. In mid-January of the following year, after the audit for the previous year has been completed and the final profits for that year have been determined, the directors meet to approve the audited accounts and to recommend to the stockholders the amount of the final dividends to be paid from those profits. English law requires that the report of the directors as adopted at the mid-January meeting, including the recommendation of the directors as to the amount of the final dividend to be paid out of the earnings ">*127 of the previous year, be incorporated in the company's annual report for that previous year and that the annual report be forwarded to the stockholders in advance of their annual meeting. At their annual meeting, which is usually held early in March, the stockholders approve the final dividend to be paid from the earnings of the previous year as recommended by the directors and the dividend is usually paid several days later.

The ordinary (common) dividends which petitioner received from its English subsidiary during the years 1957 through 1959 were in each year paid partly out of the earnings of the English subsidiary's preceding calendar year and partly out of its earnings for the current calendar year. The total dividends paid by petitioner's English subsidiary during the calendar year 1957 on its ordinary (common) stock and the source from which those dividends were paid are as follows:

Final dividend paid on Mar. 9, 1957, out of 1956 earnings	# 5,175,000
Interim dividend paid in mid-1957 out of 1957 earnings	2,587,500
Total dividends paid by petitioner's English subsidiary on its
ordinary (common) stock during 1957	# 7,762,500

The total dividends paid by petitioner's English subsidiary ">*128 during the calendar year 1958 on its ordinary (common) stock and the source from which those dividends were paid are as follows:

Final dividend paid on Mar. 8, 1958, out of 1957 earnings	# 5,175,000
Interim dividend paid in mid-1958 out of 1958 earnings	2,587,500
Total dividends paid by petitioner's English subsidiary on its
ordinary (common) stock during 1958	# 7,762,500

The total dividends paid by petitoner's English subsidiary during the calendar year 1959 on its ordinary (common) stock and the source from which these dividends were paid are as follows:

Final dividend paid on Mar. 7, 1959, out of 1958 earnings	# 5,175,000
Interim dividend paid in mid-1959 out of 1959 earnings	2,756,250
Total dividends paid by petitioner's English subsidiary on its
ordinary (common) stock during 1959	# 7,931,250

">*1239 The dividends received by petitioner during the years 1957, 1958, and 1959 on its 140 shares of preferred stock of its English subsidiary were paid out of current earnings.

During the years here involved petitioner's German subsidiary generally paid out a large portion of its earnings as dividends each year because the German Government levies a lower rate of tax on distributed income than on undistributed ">*129 income. The earnings for a particular year were distributed in the form of dividends during March of the following year. During the years here involved petitioner would lend back to its German subsidiary a part of the dividends which it received from that subsidiary during each year so as to provide the German subsidiary with sufficient working capital.

Petitioner received dividends from its German subsidiary during the calendar year 1957 in the amount of $ 1,411,537.01, of which $ 1,383,408.60 was paid out of 1956 earnings of the German subsidiary amounting to $ 3,063,169.95 (after German income taxes) and $ 28,128.41 was paid out of 1939 earnings of the German subsidiary amounting to $ 2,480,135.34 (after German income taxes). Petitioner then loaned back at interest the sum of $ 237,699.07 (DM1,000,000) out of said dividends.

Petitioner received dividends from its German subsidiary during the calendar year 1958 in the amount of $ 738,045.99 which were paid out of 1957 earnings of the German subsidiary amounting to $ 3,023,158.48 (after German income taxes). Petitioner then loaned back at interest the sum of $ 380,436.08 (DM1,600,000) out of said dividends.

Petitioner received dividends ">*130 from its German subsidiary during the calendar year 1959 in the amount of $ 2,685,628.04 which were paid out of 1958 earnings of the German subsidiary amounting to $ 3,431,111.93 (after German income taxes). Petitioner then loaned back at interest the sum of $ 2,028,780.51 (DM8,500,000) out of said dividends.

From 1842 to 1952 basic income tax acts were passed from time to time governing the charge, assessment, and levy of the income tax in the United Kingdom, but the income tax remained an annual tax in the sense that it was imposed by a Finance Act for each year. The basic act governing the charge, assessment, and levy of the income tax in the United Kingdom for the years 1957, 1958, and 1959 was the Income Tax Act, 1952.

The Income Tax Act, 1952 classified all taxable income into five basic categories or schedules (similar in this respect to predecessor income tax acts), and the same rate of tax applied to all taxable income regardless of the category or schedule under which it fell:

Schedule A -- Income derived from the ownership of land.

Schedule B -- Income derived from the occupancy of land (i.e., farming).

Schedule C -- Income derived from the ownership of Government stocks.

">*1240 Schedule ">*131 D -- Includes in the following six subdivisions, or cases, all income not covered by schedules A, B, C, or E:

Case I -- Profits from any trade.

Case II -- Profits from any profession or vocation.

Case III -- Income from interest, annuities, and annual payments received from Governmental sources.

Case IV -- Income from foreign securities.

Case V -- Income from foreign possessions other than Government securities.

Case VI -- All gains or profits not falling under schedules A, B, C, or E or under cases I, II, III, IV, or V of schedule D.

Schedule E -- Income derived from public office.

During the years 1956 through 1959 petitioner's English subsidiary paid taxes to the English Government under both schedules A and D of the Income Tax Act, 1952 and also paid a profits tax that was levied separately.

In ">*132 addition to the profits tax and the taxes directly paid by petitioner's English subsidiary under schedules A and D of the Income Tax Act, 1952, petitioner's subsidiary was required to withhold tax on rent, interest, and other obligations which it paid to third parties. Similarly, tax was withheld from petitioner's subsidiary on rent, interest, and other obligations it received from third parties.

Schedule A of the Income Tax Act, 1952, levied a tax "under this Schedule * * * in respect of the property in all lands, tenements, hereditaments and heritages in the United Kingdom capable of actual occupation" based upon its annual rental value. However, the following classes of taxpayers were exempt from the tax levied under schedule A but were required to account under case I of schedule D, at the same rate of tax as under schedule A, for their profits from or arising out of lands, tenements, hereditaments, and heritages:

(a) quarries of stone, slate, limestone or chalk; and

(b) mines of coal, tin, lead, copper, mundic, iron and other mines; and

(c) ironworks, gasworks, salt springs or works, alum mines or works, waterworks, streams of water, canals, inland navigations, docks, drains or ">*133 levels, fishings, rights of markets and fairs, tolls, railways and other ways, bridges, ferries and other concerns of the like nature having profits from or arising out of any lands, tenements, hereditaments or heritages [15 & 16 Geo. 6 & 1 Eliz. 2, ch. 10, sec. 82 at 51 (Income Tax Act, 1952)].

The tax computed under schedule A was levied on the occupier of lands, tenements, hereditaments, and heritages and was based upon the annual rental value of the property. The occupier of the property, whether the owner or the tenant, was required to pay the tax in the first instance but the burden of the tax was ultimately borne by the owner of the property. Thus, an occupier who rented the property was entitled to deduct the tax paid under schedule A from the rent payable to the owner. In other words, the owner-occupier of property directly paid the tax levied under schedule A while an owner of property who ">*1241 rented it to another indirectly paid the tax levied under schedule A. For the purpose of schedule A a long-term leaseholder, as well as the owner of a freehold (i.e., the owner of an unencumbered fee), was considered to be the owner of property, and where more than one person had a ">*134 proprietary interest in a given property the burden of the tax levied under schedule A was shared by them in proportion to their respective interests in the annual rental value of that property.

The owner of property, having paid (whether directly or indirectly through withholding) the tax levied under schedule A based upon the annual rental value of that property, was entitled to deduct the annual rental value of the property from the trading profits on which he was required to pay tax under schedule D. Since the taxes under schedules A and D were at exactly the same rate, the result was that a trading corporation such as petitioner's English subsidiary which paid tax under both schedules A and D was required to pay a total tax exactly equivalent to that which would have been paid under schedule D alone if it had not been required to pay any tax under schedule A.

If a trading corporation, such as petitioner's English subsidiary, was required to pay a tax under schedule A on the annual rental value of owned property but sustained a loss from its trading operations, then the tax paid under schedule A could be recovered to the extent of the loss from its trading operations. If the loss ">*135 from its trading operations exceeded the annual rental value on which the taxpayer had paid tax under schedule A, the excess portion of the loss could be carried forward and deducted from its trading profits in future years.

The English tax under schedule A was abolished by the Finance Act of 1963 effective for subsequent years. The effect of the abolition of the tax under schedule A has been that a trading corporation now pays a tax under schedule D in an amount exactly equivalent to the total tax which it had previously paid under schedules A and D.

During the years in issue the owner of a long-term lease, in accordance with the general principle of withholding at the source, withheld and retained tax on the ground rent payable to the holder of the reversion and such withheld and retained tax was computed at the same rate applicable to all five schedules. Similarly, the payor of interest withheld and retained on interest payable to a lender and such withheld and retained tax was computed at the same rate applicable to all five schedules. However, since the payor of ground rent or of interest had withheld and retained the tax applicable thereto, he could not deduct the ground rent ">*136 or the interest in determining his trading profits subject to tax under schedule D. Accordingly, during the years in issue, petitioner's English subsidiary withheld taxes in making payments of interest and ground rents to others and taxes were similarly ">*1242 withheld by others in making payments to petitioner's English subsidiary on its investments.

For the year 1956 petitioner's English subsidiary had total assessable profits of # 23,154,259 but since it was required to pay tax under schedule A on # 604,133, which represented the net annual rental value of its freehold and leasehold properties, the English subsidiary paid tax under schedule D computed as follows:

Total assessable profit for 1956	# 23,154,259
Deduct net rental values of freehold and leasehold
properties assessed under schedule A for 1956	604,133
Balance representing profit for 1956 assessable under
schedule D, case I	# 22,550,126
Income tax assessed under schedule D, case I, for 1956
(# 22,550,126 at 8/6d in the #)	# 9,583,803.11.0

For the year 1956 petitioner's English subsidiary paid tax computed under schedule A in the amount of # 256,759.19.8 (# 604,133 -- the net annual rental value of freehold and leasehold ">*137 properties -- at 8/6d in the #).

During the year 1956 the ground rents and interest paid to third parties by petitioner's English subsidiary on which it withheld and retained taxes exceeded by # 130,760 the investment income received by the English subsidiary on which the payors had withheld taxes, with the result that the English subsidiary withheld and retained # 55,573 more in taxes than had been withheld against it (# 130,760 at 8/6d in the #).

The total tax computed under schedules A and D which petitioner's English subsidiary was required to pay to the English Government in 1956 amounted to # 9,840,563.10.8 but its net tax liability for that year was # 9,784,990.10.8 because of the # 55,573 recovered through excess withholdings, computed as follows:

Income tax computed under schedule D, case I	# 9,583,803.11.0
Tax computed under schedule A	256,759.19.8
Total tax actually paid to English Government	# 9,840,563.10.8
Less income tax recovered by the company from rents and
interest paid less income tax withheld on investment
income received	55,573. 0.0
Total income tax borne by petitioner's English
subsidiary for 1956	# 9,784,990.10.8

In addition to the tax computed under schedules A and ">*138 D and the tax withheld on income received, petitioner's English subsidiary paid a profits tax for the year 1956 in the amount of # 2,450,161.18.0.

">*1243 For the year 1957 petitioner's English subsidiary had total assessable profits of # 24,113,815 but was required to pay tax under schedule A on # 615,185, which represented the net rental value of its freehold and leasehold properties. The English subsidiary paid tax under schedule D for the year 1957 in the amount of # 9,987,424.7.0, computed as follows:

Total assessable profit for 1957	# 24,113,815
Deduct net rental values of freehold and leasehold
properties assessed under schedule A for 1957	615,185
Balance representing profit for 1957 assessable under
schedule D, case I	# 23,498.630
Income tax assessed under schedule D, case I, for the
year 1957 (# 23,498,630 at 8/6d in the #)	# 9,986,917.15.0
Income tax assessed under schedule D, case IV
(overseas income) (# 1,192 at 8/6d in the #)	506.12.0
	# 9,987,424. 7.0

For the year 1957 petitioner's English subsidiary paid tax computed under schedule A in the amount of # 261,619.8.8 (# 615,185 -- the net annual rental value of freehold and leasehold properties -- at 8/6d in the #).

During ">*139 the year 1957 the ground rents and interest paid to third parties by petitioner's English subsidiary on which it withheld and retained taxes exceeded by # 132,641 the investment income received by the subsidiary on which the payors had withheld taxes, with the result that the English subsidiary withheld and retained # 56,372.8.6 more in taxes than had been withheld against it (# 132,641 at 8/6d in the #).

The total tax computed under schedules A and D which petitioner's English subsidiary was required to pay to the English Government for the year 1957 amounted to # 10,249,043.15.8 but its net tax liability for that year was # 10,192,671.7.2 because of the # 56,372.8.6 recovered through excess withholdings, computed as follows:

Income tax computed under schedule D, cases I and IV	# 9,987,424. 7.0
Tax computed under schedule A	261,619. 8.8
Total tax actually paid to English Government	# 10,249,043.15.8
Less income tax recovered by the subsidiary by deduction
from rents and interest paid less income tax withheld
on investments received	56,372. 8.6
Total income tax borne by petitioner's English
subsidiary for the year 1957	# 10,192,671. 7.2

">*1244 In addition to the tax computed under schedules A and ">*140 D and the tax withheld on income received, petitioner's English subsidiary paid a profits tax for 1957 in the aggregate amount of # 2,541,246.2.5.

For the year 1958 petitioner's English subsidiary had total assessable profits of # 25,695,906 but was required to pay tax under schedule A on # 654,840 representing the net rental value of its freehold and leasehold properties. The English subsidiary paid tax under schedule D for 1958 in the amount of # 9,703,878.1.6, computed as follows:

Total assessable profit for 1958	# 25,695,906
Deduct net rental values of freehold and leasehold
properties assessed under schedule A for 1958	654,840
Balance representing profit for 1958 assessable under
schedule D, case I	# 25,041,066
Income tax assessed under schedule D, case I for 1958
(# 25,041,066 at 7/9d in the #)	# 9,703,413.1.6
Income tax assessed under case IV (overseas income)
(# 1,200 at 7/9d in the #)	465.0.0
	# 9,703,878.1.6.

For the year 1958 petitioner's English subsidiary paid tax computed under schedule A in the amount of # 278,312.0.10 (# 654,840 -- the net annual rental value of freehold and leasehold properties assessed under schedule A -- at 7/9d in the #).

For the year 1958 the ">*141 ground rents and interest paid to third parties by petitioner's English subsidiary on which it withheld and retained taxes exceeded by # 187,974 the investment income received by the subsidiary on which the payors had withheld taxes, with the result that the English subsidiary withheld and retained # 79,888.19.0 more in taxes than had been withheld against it (# 187,974 at 7/9d in the #).

The total tax computed under schedules A and D which petitioner's English subsidiary was required to pay to the English Government for 1958 amounted to # 9,982,190.2.4 but its net tax liability for that year was # 9,902,301.3.4 because of the # 79,888.19.0 received through excess withholdings, computed as follows:

Income tax computed under schedule D, cases I and IV	# 9,703,878. 1.6
Tax computed under schedule A	278,312. 0.10
Total tax actually paid to English Government	# 9,982,190. 2.4
Less income tax recovered by the subsidiary by deduction
from rents and interest paid less income tax withheld
on investment income received	79,888.19.0
Total income tax borne by petitioner's English
subsidiary for 1958	# 9,902,301. 3.4

">*1245 In addition to the tax computed under schedules A and D and the tax withheld on income ">*142 received, petitioner's English subsidiary paid a profits tax for 1958 in the amount of # 2,592,309.18.7.

For the year 1959 petitioner's English subsidiary had total assessable profits of # 27,953,808.0.0 but was required to pay tax under schedule A or # 707,879 representing the net rental value of its freehold and leasehold properties. The English subsidiary paid tax under schedule D for 1959 in the amount of # 10,558,262.9.9, computed as follows:

Total assessable profit for 1959	# 27,953,808.0.0
Deduct net rental values of freehold and leasehold
properties assessed under schedule A for 1959	707,879.0.0
Balance representing profit for 1959 assessable under
schedule D, case I	# 27,245,929.0.0
Income tax assessed under schedule D, case I, for 1959
(# 27,245,929 at 7/9d in the #(	# 10,557,797.9.9
Income tax assessed under case IV (overseas income)
(# 1,200 at 7/9d in the #)	465.0.0
	# 10,558,262.9.9

For the year 1959 petitioner's English subsidiary paid tax computed under schedule A in the amount of # 278,993.2.8 (# 707,879 -- the net annual rental value of freehold and leasehold properties assessed under schedule A -- at 7/9d in the #).

The total tax computed under schedules A and D which petitioner's ">*143 English subsidiary was required to pay to the English Government for 1959 amounted to # 10,837,255.12.5 but its net tax liability for that year was # 10,712,749.14.0 because of the # 124,505,18.5 recovered through excess withholdings, computed as follows:

Income tax computed under schedule D, cases I and IV	# 10,558,262. 9.9
Tax computed under schedule A	278,993. 2.8
Total tax actually paid to English Government	# 10,837,255.12.5
Less income tax recovered by the subsidiary by deduction
from rents and interest paid less income tax withheld
on investment income received	124,505.18.5
Total income tax borne by petitioner's English
subsidiary for 1959	# 10,712,749.14.0

In addition to the tax computed under schedules A and D and the tax withheld on income received, petitioner's English subsidiary paid a profits tax for 1959 in the amount of # 2,767,448.6.0.

The tax paid by petitioner's English subsidiary under schedule D of the English Income Tax Act, 1952, for each of the years 1956 through ">*1246 1959 was levied on the subsidiary's trading profits and petitioner has claimed (and respondent has agreed) that such taxes, as well as the separately levied profits tax, are income taxes qualifying for the computation ">*144 of the foreign tax credit under the provisions of sections 901 -- 905 of the 1954 Internal Revenue Code.

III. Findings of Fact Relating to Issue Involving Computation of the Per Country Limitation

State Income and Franchise Taxes. -- During the years 1957, 1958, and 1959 petitioner operated stores in New Jersey, North Carolina, Vermont, and Virginia as follows:

	Number of stores
	1957	1958	1959
New Jersey	75	80	79
North Carolina	32	33	36
Vermont	9	8	8
Virginia	32	32	34

Petitioner was required to file a corporation franchise tax return with the State of New Jersey for the year 1957 and a corporation business tax return with the State of New Jersey for the years 1958 and 1959. For the year 1957 the New Jersey franchise tax was based upon a valuation consisting of the ratio of petitioner's assets in New Jersey to petitioner's assets everywhere. In 1958 the State of New Jersey added an additional test, i.e., income, in measuring the corporation franchise tax. The New Jersey franchise tax (sometimes referred to as the New Jersey corporation business tax) was a tax for the privilege of doing business in that State. The amounts of corporation franchise tax paid by petitioner to the State of New Jersey were ">*145 $ 49,643.05 in 1957, $ 86,580.80 in 1958, and $ 100,464.29 in 1959.

The portions of the dividends received by petitioner in 1957, 1958, and 1959 which were reported by petitioner in its returns filed with the State of New Jersey were as follows:

	1957	1958	1959
Domestic sources			$ 34.32
English subsidiary		$ 5,749,023.50	6,894,645.16
Canadian subsidiary		1,822,500.00
German subsidiary		258,316.09	939,969.85

">*1247 Petitioner filed corporation income tax returns with the State of North Carolina for the years 1957, 1958, and 1959 and paid corporation income tax for said years as follows: $ 31,352.56 in 1957; $ 28,333.22 in 1958; and $ 31,693.93 in 1959. The portions of the dividends received by petitioner in 1957, 1958, and 1959 which were reported by petitioner in its corporation income tax returns filed with the State of North Carolina were as follows:

	1957	1958	1959
Domestic sources			$ 68.65
English subsidiary
Canadian subsidiary	$ 2,025,000	$ 4,050,000
German subsidiary

For the years 1957, 1958, and 1959 the State of Vermont imposed a corporation franchise tax upon petitioner for the privilege of doing business in that State. Petitioner filed corporation franchise tax returns with the State of Vermont for each of ">*146 the years 1957, 1958, and 1959 and paid tax as follows: $ 6,371.33 in 1957; $ 5,155.01 in 1958; and $ 5,566.56 in 1959. The portions of the dividends received by petitioner in 1957, 1958, and 1959 which were reported by petitioner in its returns filed with the State of Vermont were as follows:

	1957	1958	1959
Domestic sources			$ 68.65
English subsidiary	$ 5,502,557.74	$ 5,577.417.01	7,090,858.77
Canadian subsidiary	975,609.35	1,945,783.62
German subsidiary	680,053.68	354,591.61	1,289,382.86

For the years 1957, 1958, and 1959 the State of Virginia imposed upon the petitioner a corporation income tax based upon petitioner's income earned within that State. Petitioner filed corporation income tax returns with the State of Virginia for said years and paid corporation income taxes as follows: $ 45,571.40 in 1957; $ 43,316.66 in 1958; and $ 49,320.15 in 1959. For the purpose of measuring its income earned within the State of Virginia during those years petitioner reported the following portions of dividends which it had received:

	1957	1958	1959
Domestic sources			$ 68.65
English subsidiary	$ 11,421,251.19	$ 11,498,047.00	13,789,290.31
Canadian subsidiary	2,025,000.00	4,050,000.00
German subsidiary	1,411,537.01	738,045.99	2,685,628.04

">*1248 ">*147 Foreign Travel Expenses. -- Petitioner's English subsidiary had a board of directors consisting of between 12 and 15 members during the years 1957, 1958, and 1959. Petitioner's president and executive vice president served on the board of directors of petitioner's English subsidiary and the chairman of the board of directors of petitioner's English subsidiary served on the board of directors of petitioner during the 3 years here involved. No representative of the petitioner served on the board of directors of petitioner's German subsidiary during the years 1957, 1958, and 1959.

The two representatives of petitioner on the board of directors of petitioner's English subsidiary did not regularly attend the board meetings of the English subsidiary. Either petitioner's president or executive vice president would, as a rule, visit England when the stockholders meeting of the English subsidiary was being held, usually on the second Friday in March of each year. If the board of directors of the English subsidiary happened to have a meeting at that time, the representative of petitioner would attend such board meeting. Neither of petitioner's representatives on the board of directors of ">*148 the English subsidiary ever made a special trip to England for the purpose of attending a board meeting.

In each of the years 1957, 1958, and 1959 petitioner's president and executive vice president made separate trips to England and Germany and each one visited petitioner's English and German subsidiaries. One of the executive officers would make the trip in March and the other executive officer would make the trip during the latter part of the year. Occasionally the petitioner's president or executive vice president attends shareholders meetings of the German subsidiary but not with the same consistency as either attends shareholders meetings of the English subsidiary.

The representative of the English subsidiary on petitioner's board of directors usually visits petitioner in New York City once a year, at which time he usually attends a board meeting of petitioner. The managing director of the German subsidiary visits petitioner in New York City once each year and occasionally other representatives of the German subsidiary, as well as the English subsidiary, visit the United States. While the managing director of the German subsidiary is not a member of petitioner's board of directors, ">*149 he would be invited to attend any board meetings held during his visit. Petitioner paid the expenses incurred by the officers of its English and German subsidiaries while in the United States.

Petitioner incurred travel expenses for the trips made by its president and executive vice president to England and Germany in the ">*1249 following amounts: $ 1,535 in 1957; $ 2,415 in 1958; and $ 1,971 in 1959. These expenditures included only the actual expenses of travel. The English subsidiary and the German subsidiary paid all of the hotel and other living expenses of petitioner's representatives while they were in England and Germany.

Petitioner did not maintain a buying office or any other office in England or Germany during the years here involved. Petitioner would send its own buyers abroad into foreign markets from time to time, but without any assistance from its English or German subsidiaries.

Petitioner's representatives who visited the English and German subsidiaries during the years here involved were generally concerned with checking the stores operated by the foreign subsidiaries and also with checking competitors' stores to obtain new merchandising ideas for petitioner's use. Similarly, ">*150 when representatives of the English and German subsidiaries visited the United States they would visit stores and warehouses of petitioner, as well as stores and warehouses of petitioner's competitors, in order to get new ideas for their own operations.

Executive Officer Salaries and Related Pension Costs. -- Petitioner gives a proxy once each year to vote its stock in its German subsidiary at the shareholders meeting of that company. In addition, petitioner receives a report from its German subsidiary once each month showing sales, expenses, and basic profit earned by that company for the particular month. The reports go to petitioner's chairman of the board of directors, president, vice president, and comptroller, where they are checked. If the four officers of petitioner who get the monthly reports should have any questions concerning such reports, an inquiry would be made of the managing director of the German subsidiary.

Petitioner receives a monthly summary of the operations of its English subsidiary, which summary report is distributed to petitioner's chairman of the board of directors, president, and treasurer. Petitioner's executive committee devotes some of its time to ">*151 the checking and studying of reports received from its English and German subsidiaries from the standpoint of petitioner's investment in those companies.

Respondent's allocated a portion of the salaries and pension costs of several of petitioner's executive officers to dividends received from petitioner's English and German subsidiaries. Respondent did not allocate any portion of the salaries and pension costs of those executive officers who performed duties which he considered to be definitely related to petitioner's domestic operations. The 11 executive officers whose salaries and pension costs were allocated in part to English and German dividends included the chairman of the board of directors, ">*1250 president, executive vice president, comptroller-treasurer, secretary, and several assistant secretaries and assistant treasurers. The total executives officers' salaries and pension costs, portion of which were allocated by respondent to petitioner's dividends from its English and German subsidiaries, amounted to $ 498,541 in 1957, $ 623,630 in 1958, and $ 704,479 in 1959.

Cost of Annual Report. -- Petitioner, whose stock is listed on the New York Stock Exchange, is required by the New ">*152 York Stock Exchange to publish and distribute annual reports to its shareholders. Petitioner published annual reports during each of the years 1957, 1958, and 1959 and distributed them to its shareholders. None of the annual reports was distributed to the shareholders of either the English or the German subsidiary unless a shareholder of either of those corporations happened to be a shareholder of petitioner. Petitioner's English and German subsidiaries published annual reports of their own.

Petitioner's annual reports included summaries of the operations of petitioner's English and German subsidiaries, giving such information as the net income of each subsidiary for the operating year, dividends paid, stores in operation, and plans for future expansion. For the years 1957, 1958, and 1959 petitioner incurred total costs in producing and distributing its annual financial reports in the following amounts: $ 52,508 in 1957; $ 56,532 in 1958; and $ 62,148 in 1959. Less than 1 percent of the total cost was attributable to the inclusion of information in the annual reports concerning the English and German subsidiaries.

Directors' Fees and Expenses. -- For the years 1957, 1958, and 1959 ">*153 petitioner paid fees to those directors who were not officers of petitioner and reimbursed them for their travel expenses in attending directors meetings which were usually held once each month. Petitioner paid the following amounts:

	Directors'	Directors'
Year	fees	expenses	Total
1957	$ 14,600	$ 2,934	$ 17,534
1958	13,500	4,102	17,602
1959	49,700	6,199	55,899

Cost of Annual Meeting. -- Petitioner incurred the following expenses in conducting its annual stockholders meetings for the years 1957, 1958, and 1959: $ 34,743 in 1957; $ 37,138 in 1958; and $ 29,245 in 1959. These expenses included the cost of printing and distributing the report of the meeting, travel expenses to the place of meeting, rental of the room in which the meeting was held, and cost of a luncheon served to stockholders. The report of the annual meeting was distributed only to petitioner's stockholders.

">*1251 Registrar and Transfer Agent's Fees. -- For the years 1957, 1958, and 1959 petitioner paid fees and expenses to its corporate registrar and transfer agent in the following amounts:

	Corporate	Transfer
Year	registrar	agent	Total
1957	$ 6,797	$ 138,410	$ 145,207
1958	4,101	123,041	127,142
1959	5,371	155,691	161,062

The registrar and transfer agent's fees ">*154 represent amounts paid for registering and transferring stock of the petitioner. The transfer agent also acts as disbursing agent for the payment of dividends declared by petitioner.

Petitioner's registrar and transfer agent performed no services for petitioner's English and German subsidiaries, and the registrar and transfer agent's fees during these 3 years would not have been reduced if petitioner had not owned stock in its English and German subsidiaries.

Legal Fees Relating to Federal Income Tax. -- In the years 1957, 1958, and 1959 petitioner paid legal fees with regard to matters of Federal taxation in the following amounts: $ 12,316 in 1957; $ 12,362 in 1958; and $ 12,141 in 1959. These legal fees were paid for routine Federal income tax services and did not cover any services rendered to or on behalf of petitioner's English and German subsidiaries. Neither the English nor the German subsidiary filed any returns or paid any Federal income taxes in the United States during the 3 years here involved.

Fees Paid for Outside Accounting Services. -- In the years 1957, 1958, and 1959 petitioner paid fees for outside accounting services in the following amounts: $ 85,000 in 1957; ">*155 $ 60,000 in 1958; and $ 72,500 in 1959. These fees were paid to the accounting firm of Price Waterhouse & Co. which conducted the annual audit of petitioner's books and records. The accounting firm performed no services for petitioner's English and German subsidiaries, which subsidiaries had separate accounting organizations to perform independent audits for them.

Contributions. -- From the total contributions made by petitioner during the years 1957, 1958, and 1959 in the respective amounts of $ 576,708.15, $ 575,094.98, and $ 630,885.60, respondent selected and allocated to the dividends received by petitioner from its English and German subsidiaries a portion of the following contributions: ">*1252

Charitable organization	1957	1958	1959
Junior Achievement	$ 1,500	$ 500	$ 500
Urban League	500	500	500
Amvets	250		250
United States -- German Chamber of Commerce	50	50	50
Citizens Budget Committee	500	500
United Israel Appeal	250	250	250
Citizens Public Expenditure	1,000	1,000	1,000
Salvation Army	200	200	200
United Cerebral Palsy	100	200	200
American Legion Ch. Champ	100	100	100
National Municipal League	300	300	300
YMCA			500
Mexican Chamber of Commerce	50
United Negro College	1,500	1,500	1,500
T.A. Edison Foundation	500	500	500
Boys Club of America		250
National Foundation of Infantile Paralysis		500
U.S. Committee for U.N	100	100	100
Boy Scouts of United States	500	500	500
Tax Foundation		1,250	2,500
National Foundation for Medical Ed	1,000	1,000	1,000
National Jewish Hospital	100
American Foundation of Captive Nations	100
Better Business Bureau	500	500
Friends of the Land	100	100	100
Keep America Beautiful	500	500	500
English Speaking Union	100	100	100
Committee for Economic Development		1,200	1,200
National Merit Scholarships		22,500	31,300
American Women Voluntary Service	125	125
National Planning Association		100	100
Religion in American Life	250	250
American Heritage Foundation	200	200	200
Boys Club of America	250		250
National Education Council	50	100	100
Crusade for Freedom	500	500	500
National Council of American Importers			250
ACTION		1,000	1,000
Distribution Educational Club of America			500
American Viewpoint			200
Total	11,175	36,375	46,250

">*156 None of the above contributions was made to organizations in England or Germany.

Executive Office Expenses. -- For each of the years 1957, 1958, and 1959 respondent allocated to dividends received by petitioner from its English and German subsidiaries a portion of petitioner's executive office expenses. The items of expense so apportioned and the basis on which the said expenses were apportioned are as follows:

	1957	1958
Electric light	$ 12,471.45	$ 12,475.55
Employees benefit fund	179,150.50	166,054.72
Maintenance and repairs	7,734.44	6,632.50
Postage	31,988.01	27,364.99
Rent, executive office	216,212.74	216,638.16
Salaries	861,631.21	878,070.20
Salaries, executive personnel	124,887.21	132,618.71
Stationery	59,294.34	75,464.55
Sundry expenses	200,912.96	202,088.36
Telephone and telegraph	32,454.08	32,707.95
Unemployment insurance and OASI	37,556.09	35,769.93
Executive office alteration	32,880.16	32,889.22
Depreciation-executive office fixtures	19,086.83	20,039.68
Amortization-executive office equipment	23,983.93	18,281.02
Personnel moving expense	35,915.55	56,999.11
(1)Total	1,876,159.50	1,914,094.65
(2) Allocable officers' earnings and related
pension costs	498,541.00	623,630.00
(3) Total officers' earnings and related
pension costs	911,652.00	1,086,990.00
(4) Percentage (line 2 divided by line 3)	54.6855	57.3722
Allocable executive office expenses
(line 1 x line 4)	$ 1,025,987.20	$ 1,098,169.69

">*157

	1959
Electric light	$ 12,746.07
Employees benefit fund	162,801.94
Maintenance and repairs	7,745.43
Postage	31,945.14
Rent, executive office	213,831.76
Salaries	876,352.66
Salaries, executive personnel	109,665.29
Stationery	58,209.98
Sundry expenses	296,418.49
Telephone and telegraph	42,248.93
Unemployment insurance and OASI	40,728.87
Executive office alteration	34,980.08
Depreciation-executive office fixtures	20,309.08
Amortization-executive office equipment	17,919.49
Personnel moving expense	36,161.94
(1)Total	1,962,065.15
(2) Allocable officers' earnings and related
pension costs	704,479.00
(3) Total officers' earnings and related
pension costs	1,255,810.00
(4) Percentage (line 2 divided by line 3)	56.0976
Allocable executive office expenses
(line 1 X line 4)	$ 1,100,671.46

">*1253 During the years 1957, 1958, and 1959 the 2,100 to 2,200 variety stores which petitioner operated throughout the United States, Cuba, and Puerto Rico were operated through 10 regional offices, each of which was headed by a regional vice president who was responsible for the operation of the stores in his area. Each regional vice president reported periodically to the executive office in New York City.

Each store is operated as a ">*158 unit under the direction of a store manager whose compensation is based upon the profits generated by his store. Each store pays the salaries to its employees but, with minor exceptions, all invoices for merchandise ordered by a particular store are paid by petitioner's central accounting office in Milwaukee, Wis. The manager of each store submits a weekly report to the central accounting office in Milwaukee showing the store's receipts and disbursements.

Petitioner's executive office in New York City consists of the executives and departments which direct each major function of petitioner's operations. These departments include the real estate and construction department, accounting department, restaurant department, and buying department. The accounting department supervises the operation of petitioner's central accounting office in Milwaukee which handles the detailed accounting operations from all of the stores in the United States, Cuba, and Puerto Rico and pays all invoices for merchandise. Petitioner's executive office employed between 300 and 400 employees during the years 1957, 1958, and 1959. None of these employees performed any services for petitioner's English or German ">*159 subsidiaries.

During the years here involved the buying department of petitioner's executive office consisted of buyers who examined and approved merchandise for sale by the stores in the United States, Cuba, and Puerto Rico. Such approved merchandise was included on lists which were distributed to stores through the regional offices. The stores or the merchandise manager in the regional office could then order any merchandise on the approved list directly from the supplier. The buyers in the executive office purchased very little merchandise directly and such merchandise as they did purchase directly was tested for use in stores to determine whether the merchandise should be approved for purchase by the stores generally. The buying department of the executive office did not purchase or approve any merchandise for the stores operated by petitioner's Canadian, English, or German subsidiaries during the years here involved. Petitioner's Cuban and Puerto Rican stores obtained merchandise in the same manner in which a store in the United States could obtain it.

">*1254 Petitioner's real estate and construction department in the executive office worked with the real estate department in the ">*160 regional office in developing site locations, preparing leases, and handling real estate deals involved in the acquisition, expansion, or disposition of stores in the United States, Cuba, and Puerto Rico. The real estate and construction department in the executive office performed services for petitioner's Canadian subsidiary in the same manner in which it worked with the regional offices in the United States. However, it did not perform any services for petitioner's English or German subsidiaries during the years 1957, 1958, and 1959.

The food department of petitioner's executive office supervised the operation of the lunch counters and restaurants in petitioner's stores throughout the United States, Cuba, and Puerto Rico. Approximately 1,800 of petitioner's stores operated either a lunch counter or a restaurant. The food department in the executive office has a staff of field representatives who visit stores to check food operations in conjunction with representatives of the food department of the regional offices. The food department of the executive office also prepares, checks, and approves recipes for use by the lunch counters and restaurants in the stores. Representatives ">*161 of the food department in the executive office also visit stores operated by petitioner's Canadian subsidiary to check on food operations.

The food department in petitioner's executive office did not perform any services for petitioner's English or German subsidiaries. Those subsidiaries had food facilities in their stores but such facilities were operated entirely by the particular subsidiary without any supervision from the petitioner.

The accounting department of petitioner's executive office did not perform any services for petitioner's Canadian, English, or German subsidiaries.

Petitioner charged its Canadian subsidiary during the years here involved an amount equivalent to 3 percent of petitioner's total executive office expense for the services performed by the executive office for the subsidiary. The amounts so charged to the Canadian subsidiary were $ 86,487 in 1957, $ 78,662 in 1958, and $ 75,957 in 1959.

During the years here involved petitioner's Cuban and Puerto Rican stores were operated directly by petitioner's New York regional office. Petitioner charged each of its Cuban and Puerto Rican stores during the years 1957, 1958, and 1959 for services rendered by its executive ">*162 office in the same manner and on the same basis as it charged stores in the United States for services rendered by the executive office. For the years 1957, 1958, and 1959 the portion of the total earnings and ">*1255 pension costs of petitioner's 17 executive officers which was allocated by petitioner directly to its Cuban and Puerto Rican branches was as follows:

		Pension
Year	Earnings	costs	Total
1957	$ 9,671	$ 708	$ 10,379
1958	12,187	1,250	13,437
1959	19,327	1,912	21,239

In an amendment to his answer filed in docket No. 84442 (1957) and docket No. 2130-62 (1959) respondent contends that the following items should be allocated in the amounts indicated to petitioner's Cuban and Puerto Rican stores for the purpose of computing petitioner's foreign tax credit limitation under section 904 applicable to Cuba and Puerto Rico:

Cuba
	1957	1958	1959
State income and franchise taxes	$ 23,079.98	$ 22,510.37	$ 37,431.91
Officer earnings and pension costs	9,202.18	9,819.83	16,098.65
Total allocated	32,282.16	32,330.20	53,530.56
Puerto Rico
State income and franchise taxes	$ 2,951.54	$ 8,291.72	$ 11,952.18
Officer earnings and pension costs	1,176.82	3,617.17	5,140.35
Interest expense	23,216.74	18,058.37	53,141.86
Total allocated	1">*163 27,345.10	29,967.26	70,234.39

In computing the State income and franchise taxes deemed applicable to petitioner's earnings from its Cuban and Puerto Rican stores the respondent applied to the total State income and franchise taxes paid by petitioner for each of the years 1957, 1958, and 1959 a ratio representing the petitioner's earnings from its Cuban and Puerto Rican stores, respectively, to its total taxable income (less the dividends received from its English, German, and Canadian subsidiaries).

In computing the officer earnings and pension costs deemed applicable to petitioner's earnings from its Cuban and Puerto Rican stores the respondent first determined the portion of the officer earnings and pension costs attributable to the Cuban and Puerto Rican stores. Respondent then allocated such portion of the total officer earnings and pension costs between the two countries on the basis of the ratio of the earnings from each country to the combined earnings of both countries.

">*1256 In computing the assumed interest expense to be allocated to petitioner's income from its Puerto Rican stores the respondent applied the ">*164 rate of 5 percent to petitioner's net investment in its Puerto Rican stores less the earnings from those stores in each of the years here involved.

In his amended answers filed in docket No. 84442 (1957) and docket No. 2130-62 (1959) respondent also contends that two classes of expenses (one designated as direct and the other as indirect) incurred by petitioner should be allocated to the dividends received by petitioner from its English and German subsidiaries for the purpose of computing the numerator of the fraction under section 904 which limits the amount of the allowable foreign tax credit.

The two categories of direct expenses which respondent has allocated to the dividends received by petitioner from its English and German subsidiaries and his method of allocation are as follows:

	1957	1958
n11. State income and franchise taxes	$ 12,254.67	$ 17,066.27
2. Foreign travel expenses of officers on trips to
Britain and Germany	1,535.00	2,415.00
3. Total direct expenses	13,789.67	19,481.27
4. Percent -- English dividend to total of English
and German dividends.	89.0015	93.9686
5. Percent -- German dividend to total of English
and German dividends.	10.9985	6.0314
6. Amount allocable to English dividend (line 3 x
line 4)	12,273.01	18,306.28
7. Amount allocable to German dividend (line 3 x
line 5)	1,516.66	1,174.99

">*165

	1959
1.1 State income and franchise taxes	$ 23,006.19
2. Foreign travel expenses of officers on trips to
Britain and Germany	1,971.00
3. Total direct expenses	24,977.19
4. Percent -- English dividend to total of English
and German dividends.	83.6997
5. Percent -- German dividend to total of English
and German dividends.	16.3003
6. Amount allocable to English dividend (line 3 x
line 4)	20,905.83
7. Amount allocable to German dividend (line 3 x
line 5)	4,071.36

The several categories of indirect expenses which respondent has allocated to the dividends received by petitioner from its English and German subsidiaries and his method of allocation are as follows:

	1957
1. Executive office salaries and related pension cost	$ 498,541.00
2. Cost of annual report	52,508.00
3. Directors' fees and expenses	17,534.00
4. Cost of annual meeting	34,743.00
5. Cost of registrar and transfer agent's fees	145,207.00
6. Legal fees relating to Federal income tax	12,315.88
7. Cost of outside accounting services	85,000.00
8. Contributions	11,175.00
9. Executive office expenses	1,025,987.20
10. Total indirect expenses	1,883.011.08
11. Ratio of dividends from its English and German subsidiaries
to petitioner's total gross income	3.9087
12. Amount of indirect expenses allocable to petitioner's
English and German dividends (line 10 x line 11)	73,601.25
13. Percent -- petitioner's English dividend to total of its
English and German dividends	89.0015
14. Portion of indirect expenses allocable to petitioner's
English dividends (line 12 x line 13)	$ 65,506.22
15. Percent -- petitioner's German dividend to total of its
English and German dividends	10.9985
16. Portion of indirect expenses allocable to petitioner's
German dividends (line 12 x line 15)	$ 8,095.03

">*166

	1958
1. Executive office salaries and related pension cost	$ 623,630.00
2. Cost of annual report	56,532.00
3. Directors' fees and expenses	17,602.00
4. Cost of annual meeting	37,138.00
5. Cost of registrar and transfer agent's fees	127,142.00
6. Legal fees relating to Federal income tax	12,361.91
7. Cost of outside accounting services	60,000.00
8. Contributions	36,375.00
9. Executive office expenses	1,098,169.69
10. Total indirect expenses	2,068,950.60
11. Ratio of dividends from its English and German subsidiaries
to petitioner's total gross income	3.6277
12. Amount of indirect expenses allocable to petitioner's
English and German dividends (line 10 x line 11)	$ 75,055.32
13. Percent -- petitioner's English dividend to total of its
English and German dividends	$ 93.9686
14. Portion of indirect expenses allocable to petitoner's
English dividends (line 12 x line 13)	$ 70,528.43
15. Percent -- petitioner's German dividend to total of its
English and German dividends	6.0314
16. Portion of indirect expenses allocable to petitioner's
German dividends (line 12 x line 15)	$ 4,526.89

1. Executive office salaries and related pension cost	$ 704,479.00
2. Cost of annual report	62,148.00
3. Directors' fees and expenses	55,899.00
4. Cost of annual meeting	29,245.37
5. Cost of registrar and transfer agent's fees	161,062.00
6. Legal fees relating to Federal income tax	12,141.28
7. Cost of outside accounting services	72,500.00
8. Contributions	46,250.00
9. Executive office expenses	1,100,671.46
10. Total indirect expenses	2,244,396.11
11. Ratio of dividends from its English and German subsidiaries
to petitioner's total gross income	4.6079
12. Amount of indirect expenses allocable to petitioner's
English and German dividends (line 10 x line 11)	$ 103,419.53
13. Percent -- petitioner's English dividend to total of its
English and German dividends	83.6997
14. Portion of indirect expenses allocable to petitioner's
English dividends (line 12 x line 13)	$ 86,561.84
15. Percent -- petitioner's German dividend to total of its
English and German dividends	16.3003
16. Portion of indirect expenses allocable to petitioner's German
dividends (line 12 x line 15)	$ 16,857.69

">*167 ">*1257 OPINION

Issue I. Eligibility for Foreign Tax Credit of Certain Taxes Paid to Great Britain

Prior to 1918, taxes paid to foreign countries were allowed as a deduction only from United States income with the result that the same income was often subject to taxation by two sovereigns, i.e., the United States and the foreign country. In order to mitigate this heavy burden of double taxation, Congress included within the Revenue Act of 1918 provisions allowing a credit, as distinguished from a deduction, against the United States tax for certain taxes paid to foreign countries and United States possessions. Secs. 222 and 238, Revenue Act of 1918; H. Rept. No. 767, 65th Cong., 2d Sess. (1918), 1939-1 C.B. 93; 56 Cong. Rec. 677-678 (1918); Burnet v. Chicago Portrait Co., 285 U.S. 1">285 U.S. 1, 285 U.S. 1">7 (1932). Successor provisions pertaining to the foreign tax credit are currently embodied in sections 901 through 905 of the Code. Section 901 provides in part that the taxpayer may elect to have the amount of any "income, war profits, and excess profits taxes" paid to a foreign country or United States possession plus any such taxes deemed to have been paid under section 902 credited against his United States">*168 tax liability. Under section 902, a domestic corporation, which owns 10 percent or more of the voting stock of a foreign corporation from which it receives dividends, is deemed for purposes of the foreign tax credit to have paid the foreign income, war profits, and excess profits taxes paid by the foreign corporation with respect to such dividends.

Petitioner contends at the outset that inasmuch as it owned 52.7 percent of the voting stock of F. W. Woolworth & Co., Ltd. (England), during the years involved herein, it is entitled to a credit under ">*1258 sections 901(a)^2">*169 and 902(a)(1)^3">*170 for certain taxes paid by such British subsidiary during the years 1957, 1958, and 1959 under schedule A of the English Income Tax Act of 1952. Respondent has allowed petitioner a foreign tax credit for the years involved herein with respect to certain separately levied profits taxes and certain taxes paid by petitioner's British subsidiary under schedule D of the English Income Tax Act, 1952. However, as regards the schedule A taxes at issue, respondent argues that such taxes do not qualify as "income" taxes within the intendment of sections 901 and 902. We are constrained to agree with the respondent.

Petitioner unsuccessfully litigated this issue once before in the case of F. W. Woolworth Co. v. United States, 15 F. Supp. 679">15 F. Supp. 679 (S.D.N.Y. 1936), affirmed on this issue 91 F.2d 973">91 F.2d 973 (C.A. 2, 1937), certiorari denied 302 U.S. 768">302 U.S. 768 (1937). Therein the District Court and the Second Circuit both held that taxes paid by petitioner's British subsidiary under schedule A of the British Income Tax Act of 1918 (the provisions of which are in all material respects the same as those under schedule A of the British Income Tax Act of 1952) did not for purposes of the foreign tax credit constitute "income taxes" within the meaning of section 238(e), I.R.C. 1921 (progenitor of section 902, I.R.C. 1954). Nevertheless, petitioner contends on brief that the earlier case was submitted on written stipulation and that the result therein might well have been different if the District Court and Second Circuit had had the benefit of the testimony of petitioner's ">*171 expert witness herein, Frank Heyworth Talbot (hereinafter referred to as Talbot), an English barrister who has specialized in British revenue law since 1931. While we indeed found Talbot's testimony to be most helpful and enlightening with respect to an understanding of the history, intent, and operation of the British Income Tax Act of 1952, ">*1259 such testimony has served to reinforce our conviction that the earlier F. W. Woolworth Co. case was correctly decided on this issue.

Talbot's testimony and other evidence of record establish the following facts regarding the Income Tax Act, 1952, which governed the charge, assessment, and levy of income tax in the United Kingdom during the years involved herein. That Act classified all taxable income into five basic categories or schedules:

Schedule A -- Income derived from the ownership of land.

Schedule B -- Income derived from the occupancy of land (i.e., farming).

Schedule C -- Income derived from the ownership of government stocks.

Schedule D -- Income not covered by schedules A, B, C, or E is included in the following six subdivisions or cases:

Case I -- Profits from any trade.

Case II -- Profits from any profession or vocation.

Case III -- Income ">*172 from interest, annuities, and annual payments received from governmental sources.

Case IV -- Income from foreign securities.

Case V -- Income from foreign possessions other than government securities.

Case VI -- All gains or profits not falling under schedules A, B, C, or E or under cases I, II, III, IV, or V of schedule D.

Schedule E -- Income derived from public office.

The same rate of tax applied to all taxable income regardless of the schedule applicable to such income. Schedule A of the Income Tax Act, 1952, levied a tax "in respect of the property in all lands, tenements, hereditaments and heritages in the United Kingdom capable of actual occupation," based upon its annual rental value. ^4">*174 The occupier of the property, whether the owner of the tenant, was required to pay the tax under schedule A in the first instance, but the burden of the tax was ultimately borne by the owner. Thus, if the occupier was a tenant, he was entitled to deduct the tax paid under schedule A from the rent payable to the owner. A long-standing controversy among United Kingdom attorneys concerning the proper characterization ">*1260 of the tax under schedule A was laid to rest in the case of London County Council ">*173 v. Attorney General, [1901] A.C.26. In that case the House of Lords unanimously held that the tax under schedule A, just as the tax levied under all other schedules of the Act, was an income tax rather than a property tax.

In determining whether the tax under schedule A of the Income Tax Act, 1952, qualifies as an "income tax" within the meaning of sections 901 and 902, the characterization of the tax under United Kingdom law is far from conclusive. It is well settled that the standard to be applied in making this determination is whether the foreign tax is the substantial equivalent of an "income tax" as that term is used and understood under the revenue laws of the United States. Biddle v. Commissioner, 302 U.S. 573">302 U.S. 573 (1938); Commissioner v. American Metal Co., 221 F.2d 134, 137 (C.A. 2, 1955), affirming 19 T.C. 879">19 T.C. 879 (1953), and the cases cited therein. The United States concept of income has been defined as "a gain realized or a profit derived from capital, labor, or both." Keasbey & Mattison Co. v. Rothensies, 133 F.2d 894 (C.A. 3, 1943), and the authority cited there. Thus, it can be seen that the United States concept of "income" is based upon gain or profit realized by the taxpayer (i.e., net ">*175 income as opposed to gross income, gross sales, or some other basis). See Allstate Insurance Co. v. United States, 419 F.2d 409, 414 (Ct. Cl. 1969). By no stretch of the imagination could it be said that the tax under schedule A on the ownership of property as measured by its annual rental value, which may be an estimated figure, falls within the scope of this concept.

The testimony of Talbot buttresses our conclusion that the tax under schedule A is not the substantial equivalent of an "income tax" as that term is understood under United States revenue laws. Talbot's explanation of the nature and operation of the tax under schedule A in response to the hypothetical situation of an owner-occupier of property having an annual rental value of $ 20,000 was as follows:

In our concept, it's the concept of our law from very early days, and it is one that you here may not share as a concept, a person who has the ownership and occupation of land, the annual value of which is $ 20,000 * * * is deemed to have an income, that is to say, he has a notional income * * * of $ 20,000 by reason of the fact that he has the ownership of property which he could let for $ 20,000 but he chooses to occupy ">*176 it himself and, therefore, he is regarded as the notional recipient of a $ 20,000 benefit.

Respondent would have us classify the tax under schedule A as a property tax. But the tax does not appear to be a true ad valorem property tax as that term is used in the United States inasmuch as the amount thereof is measured by the annual rental value of the property rather than its fair market value. However this may be, it seems clear that the tax under schedule A is not an income tax within the United States">*1261 concept of that term. We are thus reminded of the opinion written by Judge Learned Hand on behalf of the Second Circuit in F. W. Woolworth Co. v.United States, supra at 977, wherein it is stated: "A tax levied upon the use of land -- however described -- is not an 'income tax' of the kind here intended; it is not paid upon accumulated profits except by the fiction of treating the value of the land when occupied as a profit." We deem this opinion to be controlling of the immediate issue at hand, and therefore hold that the taxes paid by petitioner's British subsidiary to Great Britain under schedule A during the years 1957, 1958, and 1959 are not "income taxes" eligible for the ">*177 foreign tax credit under sections 901 and 902 of the Code.

Subsequent to the decision in 15 F. Supp. 679">F. W. Woolworth Co. v. United States, supra, section 131(h), I.R.C. 1939 (predecessor of section 903, I.R.C. 1954), was enacted as a part of the Revenue Act of 1942. That section provides that for purposes of the foreign tax credit provisions "the term 'income, war profits, and excess profits taxes' shall include a tax paid in lieu of a tax on income, war profits, or excess profits otherwise generally imposed by any foreign country or by any possession of the United States." Petitioner advances the position that the taxes involved herein at least qualify as "a tax paid in lieu of a tax on income" within the meaning of section 903. Careful scrutiny of the legislative history of section 903, and of the regulations and case law interpreting that section compels us to reach a contrary conclusion.

The legislative history of the 1942 amendment adding the "in lieu" provision clearly manifests an intent to extend the scope of creditable foreign income taxes beyond the narrow confines of the United States concept of a tax imposed upon net income. See S. Rept. No. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 602; ">*178 Statement of Mitchell B. Carroll, representing the National Foreign Trade Council, Hearings before the Senate Committee on Finance on the Revenue Act of 1942, 77th Cong., 2d Sess., pp. 206, 207-208, 210-212, 214-217. The Senate Finance Committee report provides in pertinent part, at 602:

Your committee believes further amendments should be made in section 131. Under that section as it now stands, a credit is allowed against United States tax for income, war profits, or excess profits taxes paid or accrued to any foreign country or to any possession of the United States. In the interpretation of the term "income tax," the Commissioner, the Board, and the courts have consistently adhered to a concept of income tax rather closely related to our own, and if such foreign tax was not imposed upon a basis corresponding approximately to net income it was not recognized as a basis for such credit. Thus if a foreign country in imposing income taxation authorized, for reasons growing out of the administrative difficulties of determining net income or taxable basis within that country, a United States domestic corporation doing business in such country to pay a tax in lieu of such income tax ">*179 but measured, for example, by gross income, gross ">*1262 sales or a number of units produced within the country, such tax has not heretofore been recognized as a basis for a credit. Your committee has deemed it desirable to extend the scope of this section. * * *

While the liberalizing congressional intent underlying the enactment of the predecessor of section 903 is evident, the legislative history fails to clearly delineate the outer limits of taxes that will qualify as "in lieu" taxes under section 903. It is patent that the instant case does not present the situation described in the Senate Finance Committee report where "for reasons growing out of the administrative difficulties of determining net income" the foreign country imposed a substitute tax measured by "gross income, gross sales, or a number of units produced within the country." Of course, this example is offered only by way of illustration in the Senate Finance Committee report, and presumably was not intended to serve as the sine qua non qualification as an "in lieu" tax under section 903.

Nevertheless, our research of the cases arising under section 903 and its predecessor ( sec. 131(h), I.R.C. 1939), fails to reveal ">*180 any case wherein the foreign tax credit has been extended to substitute taxes measured, as in the instant case, on a basis other than gross income, gross sales, or units of production. Moreover, of the cases decided to date, the case which in our view most closely parallels the case at bar was decided adversely to the petitioner's contentions herein, i.e., Lanman & Kemp-Barclay & Co. of Colombia, 26 T.C. 582">26 T.C. 582 (1956). That case involved a United States corporation operating in Colombia which paid both an income tax and a patrimony tax to Colombia. The patrimony tax, which was levied upon certain real and personal property reduced by debts and various exemptions, was based upon the presumption that every piece of property has a certain productive ability and the failure of the owner to achieve a return therefrom cannot deprive the State of its right to receive revenue from this potential. Under Colombian law, the patrimony tax was deemed to be a supplement to and indivisible from the income tax. Based upon the foregoing facts, this Court held that the Colombian patrimony tax failed to qualify as either an income tax or as a tax in lieu of an income tax within the meaning of the predecessors ">*181 of sections 901 and 903. In accord, Abbot Laboratories International Co. v. United States, 160 F. Supp. 321">160 F. Supp. 321 (N.D. Ill. 1958), affirmed per curiam 267 F.2d 940 (C.A. 7, 1959). We have been unable to discern any material distinction between Lanman & Kemp-Barclay & Co. of Colombia, and the instant case sufficient to produce a different result herein.

In support of his position that the tax under schedule A is a tax in lieu of an income tax, petitioner constructs an ingenious argument to show that the instant case fits the mold of the section 903 regulations. ">*1263 Section 1.903-1(a), Income Tax Regs., provides that taxes imposed by a foreign country will qualify as a tax paid in lieu of an income tax if the following conditions are met: (1) The foreign country has in force a general income tax law; (2) the taxpayer claiming the credit would, in the absence of a specific provision applicable to such taxpayer, be subject to such general income tax law; (3) the general income tax is not imposed upon the taxpayer subject to the substituted tax. Petitioner relies upon expert testimony and other evidence of record to establish that: (1) The tax under schedule D levies a general income tax; (2) ">*182 under the provisions of the British Income Tax Act of 1952, petitioner was entitled to reduce its trading profits subject to tax under schedule D by the amount subject to tax under schedule A; (3) consequently the tax under schedule A was merely a substitute tax imposed in lieu of the general income tax under schedule D. Although at first blush this statutory scheme may appear to satisfy the requirements of the regulations, petitioner's argument fails to explain why (if the schedule A tax is truly only a substitute tax) an owner-occupier would owe a tax under schedule A where it has no trading profits whatsoever or where its trading profits are less than the amount subjects to tax under schedule A. Viewed in this posture it can be seen that the tax under schedule A is in substance an additional tax based upon the fair rental value of property owned and occupied by petitioner rather than a substitute for a general income tax.

In support of his position that the tax under schedule A is a tax in lieu of an income tax within the intendment of section 903, petitioner relies upon Missouri Pacific Railroad Co. v. United States, 392 F.2d 592 (Ct. Cl. 1968); United States v. Occidental Life Insurance Co. of Cal., 385 F.2d 1">*183 (C.A. 9, 1967); Equitable Life Assurance Soc. of U.S. v. United States, 366 F.2d 967 (Ct. Cl. 1966); and Prudential Insurance Co. of America v. United States, 319 F.2d 161 (Ct. Cl. 1963). These cases are readily distinguishable from the case at bar inasmuch as they all involve taxes imposed upon gross income or gross sales and consequently clearly qualify as "in lieu" taxes within the legislative purpose underlying the enactment of section 903. In sharp contrast, the tax involved herein is imposed upon "notional" or imputed income measured by the annual rental value of property owned and occupied by the petitioner.

In view of the foregoing, we hold that the tax paid by petitioner's British subsidiary under schedule A of the British Income Tax Act, 1952, does not qualify as an income tax or a tax in lieu of an income tax within the meaning of sections 901, 902, and/or 903.

">*1264 Issue II. Computation of the Per Country Limitation

During the years involved herein, section 901 provided that the amount of foreign tax credit allowed to offset United States taxes was "Subject to the limitation of section 904." Section 904 in turn provided that the credit allowed with respect to taxes paid to any ">*184 country "shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources within such country * * * bears to the entire taxable income for the same taxable year." This limitation (commonly referred to as the per country limitation) ⁵ on the maximum amount allowable as a foreign tax credit may be expressed by means of the following formula:

Maximum credit allowed for taxes paid to country in question = Taxable income from country in question / Total taxable income x U.S. tax before credit for foreign taxes

The per country limitation is designed to prevent the foreign tax credit from being used to offset U.S. taxes properly attributable to domestic source income. H. Rept. No. 708, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 473; Erich O. Grunebaum, 50 T.C. 710">50 T.C. 710, 50 T.C. 710">717 (1968), affd. 420 F.2d 332 (C.A. 2, 1970).

The ">*185 present controversy revolves around the numerator (i.e., taxable income of the particular foreign country involved) of the limiting fraction set forth above. For purposes of computing the per country limitation with respect to taxes paid by petitioner's subsidiaries to England and Germany and taxes paid by petitioner to Cuba and Puerto Rico, respondent seeks to allocate various expenses of petitioner's executive office, certain State income and franchise taxes and other general expenses to the dividend income received by petitioner from its English and German subsidiaries and to the income derived by petitioner from the operation of its Cuban and Puerto Rican branch offices. Of course, the end result of thus diminishing the numerator of the limiting fraction in computing the per country limitation with respect to each of these countries is a concomitant reduction of the maximum credit allowed petitioner for taxes paid or deemed paid to such countries.

Inasmuch as respondent first raised this issue by way of amendment to his answer, the burden of proof with respect thereto rests squarely with him. Rule 32, Tax Court Rules of Practice. In support of his ">*1265 position, respondent introduced ">*186 the testimony of Revenue Agent Morris Pliskow to show that the allocations at issue were made in accordance with sections 861 and 862 and the regulations promulgated thereunder. ⁶

Section 861 defines gross and taxable income derived from domestic sources, while section 862 defines gross and taxable income derived from foreign sources. Subsection 862(a) enumerates various items of gross income to be treated as income from sources outside the United States. Subsection 862(b) then sets forth the following method of determining taxable income from foreign sources:

(b) Taxable Income From Sources Without United States. -- From the items of gross income specified in subsection (a) there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be treated ">*187 in full as taxable income from sources without the United States.

Section 1.862-1(b), Income Tax Regs., provides that the taxable income from sources without the United States shall be determined on the same basis as that used in section 1.861-8, Income Tax Regs., for determining taxable income from sources within the United States. Section 1.861-8(a) of the regulations provides in part that from the items of gross income includable in income from sources within the United States "there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses, or deductions which cannot definitely be allocated to some item or class of gross income." The regulation further states that the "ratable part is based upon the ratio of gross income from sources within the United States to the total gross income."

On August 2, 1966, respondent published in the Federal Register (31 Fed. Reg. 10405) a proposed amendment to section 1.861-8, Income Tax Regs. These proposed regulations are entirely consistent with the existing regulations, and simply provide a more detailed explanation of the manner in which deduction ">*188 items are to be allocated and apportioned among various items and classes of income. These proposed regulations have not as yet been formally adopted. ^7">*189 Consequently, they carry no more weight than a position advanced on brief ">*1266 by the respondent. Nevertheless, Agent Pliskow testified that he relied upon these proposed regulations in making the allocations in question, and respondent's arguments with respect to this issue are cast in the framework of these regulations. In order to fully consider and respond to respondent's position, we find it necessary to touch upon these proposed regulations. In so doing, however, we are not to be understood as passing on, with either approval or disapproval, the merits of such regulations. We deem these proposed regulations to be tantamount to a position taken by respondent on brief, and they shall be dealt with by us accordingly.

The proposed regulations set forth one group of rules for the allocation and/or apportionment of deductions "definitely related" to one or more items of gross income, and a separate set of rules for deductions which are not "definitely related" to one or more income items. Subsection 1.861-8(a)(3)(i) of these proposed regulations provides that "a deduction shall be considered definitely related to one or more items or classes of gross income if it is incurred in whole or in material part as a result of, or incident to, the activities from which such gross income is derived, or if it relates to a deduction which is incurred in whole or in material part as a result of, or incident to, the activities from which such gross income is derived." Where a deduction item is definitely related to more than one item or class of gross income, sections 1.861-8(a)(2)(i) and 1.861-8(a)(4)(i) of the proposed regulations state that such deduction shall be allocated to all such items or classes ">*190 of gross income, and, if necessary, apportioned "on a reasonable basis considering the particular characteristics of the activities producing such items or classes of gross income and the relative benefit of such activities to such items or classes of gross income." Where a deduction is not definitely related to any particular item or class of gross income, sections 1.861-8(a)(2)(ii) and 1.861-8(a)(4)(ii) provide that such deduction "shall be apportioned ratably among such items or classes of gross income in the same proportion that the amount of each such item or class of gross income bears to the amount of all such items or classes of gross income."

Careful consideration of the testimony of Agent Pliskow and the other evidence of record fails to convince us of the correctness of respondent's adjustments relating to the maximum foreign tax credit allowable to petitioner for taxes paid or deemed paid to England, Germany, Puerto Rico, and Cuba. In our view, this same result would obtain under either the existing or the proposed section 861 regulations. The ratio decidendi">*191 compelling this conclusion, as regards each of the expense items in question, is set forth in the ensuing discussion.

">*1267 A. Deduction items allocated as being definitely related to dividends received from English and German subsidiaries

Agent Pliskow allocated a portion of various State income and franchise taxes paid by petitioner and certain foreign travel expenses incurred by two of petitioner's executive officers to the dividend income received by petitioner from its English and German subsidiaries on the basis that such expenses were definitely related thereto.

With respect to the income and franchise taxes paid by petitioner to certain States (i.e., Virginia, New Jersey, Vermont, and North Carolina), respondent argues that since for purposes of computing such taxes petitioner was required to include within its tax base the dividend income received from its English and German subsidiaries, then the increment in tax resulting therefrom should be allocated to such dividend income. Although it does appear that the inclusion of the dividend income at issue in petitioner's gross income for purposes of computing certain corporation income and franchise taxes paid by petitioner to Virginia, ">*192 New Jersey, and Vermont⁸ ultimately increased such taxes, the record clearly shows that any such increment was so slight as to be immaterial. Painstaking perusal of each of petitioner's State tax returns relating to the State franchise and corporation income taxes in question reveals that in every instance where the dividend income from the English and German subsidiaries was included in petitioner's tax base, such dividend income represented less than 5 percent of petitioner's gross income from all sources. Moreover, careful examination of the method employed in computing the amount of each of these State taxes fails to demonstrate how the inclusion of the dividend income at issue in making such computation could possibly result in an increment in petitioner's tax liability that would be any greater than 5 percent. ^9">*194 De minimis non curat lex. Indeed, the proposed regulations relied upon by respondent to show that the increment in State taxes is definitely related to foreign source income provide that a deduction item is definitely related to a class of income "if it is incurred in whole or in material part as a result of, or incident to, the activities from which such gross income ">*193 is derived." (Emphasis ">*1268 supplied.) In our view, respondent has failed to show that a "material part" of the State taxes involved herein are definitely related to foreign source income. We therefore conclude that such taxes are wholly related to domestic source income, thereby obviating the need for an allocation under section 862(b).

As regards the foreign travel expenses incurred by petitioner's executive officers, the record herein shows that during the years 1957 through 1959 petitioner's president and executive vice president served on the board of directors (consisting of 12 to 15 members) of petitioner's English subsidiary, and the chairman of the board of directors of the English subsidiary served on petitioner's board of directors. Petitioner had no representatives on the board of directors of the German subsidiary during this period. Petitioner's two members of the British subsidiary's board of directors did not regularly attend the meetings of the British subsidiary's board of directors. Either the president or executive vice president of petitioner would make an annual visit to England to attend the annual March stockholders meeting of the British subsidiary and would, on that visit, attend any board of directors meeting which might be held. Petitioner's president or executive vice president also occasionally attended stockholders meetings of the German subsidiary. In addition to the annual trip to England to attend the ">*195 stockholders meeting of the English subsidiary, one of these executive officers would also travel to Europe in the latter part of the year and visit the English and German subsidiaries.

In support of his position that the foreign travel expenses of petitioner's president and executive vice president are definitely related to the dividends petitioner received from the English and German subsidiaries, respondent points to several instances over a 5-year period (1955-59) in which petitioner's directors or executive officers took some action or weighed the merits of certain broad policy modifications in connection with the British and German subsidiary. ¹⁰ It is evident that these two subsidiaries represented a substantial investment on the part of petitioner and we believe that the attention paid to these subsidiaries by petitioner's top executives was a normal part of their duties on behalf of petitioner. See Columbian Rope Co., 42 T.C. 800">42 T.C. 800, 42 T.C. 800">814 (1964). Whatever activity was undertaken by petitioner's top executives in this area, including the annual trips to England and Germany, was performed ">*1269 for the benefit of the petitioner, not for the foreign subsidiaries, and was in furtherance ">*196 of petitioner's broad concern as a majority stockholder in the general soundness of a valuable investment.

There is an additional reason for rejecting respondent's allocation of the foreign travel expenses at issue to petitioner's dividend income. The evidence shows that it was the practice of petitioner and the foreign subsidiaries to share the overall expenses incurred on such trips, with petitioner paying for the transportation expenses and with the foreign subsidiaries paying the hotel expenses and other incidental expenses in their ">*197 respective countries. In effect, petitioner has already made an apparently reasonable allocation of the total expenditures incurred by its two executives on their annual visits to England and Germany and we can perceive no reason to disturb such allocation. We note that section 1.861-8(a)(4)(i), Proposed Income Tax Regs., provides that "If a taxpayer has employed in a consistent manner a method of apportionment which is reasonable and in keeping with sound accounting practice, such method will not be disturbed."

B. Deduction items ratably apportioned to dividend income from English and German subsidiaries as being not definitely related to any item of income

Agent Pliskow ratably apportioned certain expenses of petitioner's executive office and various other expenses (i.e., executive officer salaries and related pension cost, cost of annual report, director's fees and expenses, cost of annual stockholders meeting, registrar and transfer fees, attorneys' fees for advice on Federal tax matters, fees for outside accounting services, and contributions) between the dividend income petitioner received from its English and German subsidiaries and petitioner's domestic source income on the ">*198 ground that such deductions were not definitely related to any item or class of income. We must disagree. In our view, the executive office and other expenses at issue are definitely related to petitioner's domestic source income, and consequently, apportionment to foreign source income is unwarranted.

The credible testimony of petitioner's witnesses and other evidence of record convinces us that petitioner's executive officers were primarily concerned with the petitioner's extensive domestic retail operations, which included a chain of approximately 2,000 variety stores. The record herein shows that petitioner made no purchases of merchandise for its British or German subsidiaries. Nor did petitioner perform any other services or otherwise participate to any significant extent in the actual operations of these subsidiaries. The British subsidiary's internal organization for the purpose of operating its approximately 1,100 stores, was very similar to that of petitioner in the ">*1270 United States, with an executive office and with several district offices. The internal structure of the various departments was also patterned after the departments in petitioner's operational structure. ">*199 The German subsidiary, which operated less than 100 stores during the period here involved, was more comparable to one of petitioner's district offices in the United States, and its entire operation was conducted through a single office. As far as this record indicates both the British subsidiary and the Germany subsidiary were autonomous and operated independently of the parent corporation.

Respondent's proposed regulations provide that a deduction shall be considered definitely related to a class of income if it is incurred "in whole or in material part as a result of, or incident to, the activities from which such income is derived." If we apply this test, it clearly appears from respondent's own computations that a material part of the executive office and other expenditures in dispute was incurred in connection with petitioner's United States income. Of petitioner's total executive office and other expenses, respondent has allocated only approximately 4 percent thereof to foreign source income, with the remaining 96 percent being allocated to United States source income. These percentages indicate quite persuasively that the expenditures in question were definitely related ">*200 to petitioner's domestic sources of income; a fortiori the need for an allocation under section 862(b) cannot arise.

C. Deduction items allocated to income of Cuban and Puerto Rican branch Stores

Respondent allocated a portion of certain domestic expenditures to the income received by petitioner from its Cuban and Puerto Rican branch operations on the basis that such deduction items were related thereto. Petitioner operated these stores in 1957, 1958, and 1959 directly under the supervision of its New York regional office and therefore allocated a portion of its executive office expenses on the same basis as such expenses were allocated by petitioner to its stores in the United States. Respondent made allocations to these stores of the executive officers' earnings and pension costs in amounts which differ slightly from the allocations already made by petitioner. Respondent also allocated to the Cuban and Puerto Rican stores a portion of petitioner's State income and franchise taxes. With respect to the Puerto Rican stores, respondent also determined that "interest expense" should be allocated to the income received from such stores for the years 1957, 1958, and 1959 in the respective ">*201 amounts of $ 23,216.74, $ 18,058.37, and $ 53,141.86. Respondent's method for computing the allocations of the ">*1271 various items to be made to the income received by petitioner from its Cuban and Puerto Rican stores is set forth in our Findings of Fact and need not be repeated here.

We do not believe that any portion of the State franchise and corporation income taxes is allocable to the Cuban and Puerto Rican stores under section 862(b) for the purpose of computing the limiting fraction on foreign tax credit under section 904. Our discussion above with respect to the allocation of such taxes to dividend income received from petitioner's British and German subsidiaries is equally applicable here. Respondent's own computations show Puerto Rican and Cuban earnings combined represent approximately 3 percent or less of the tax base used for computing the State corporation income and franchise taxes in question. It is apparent that the increment in State income and franchise taxes resulting from the inclusion of such Cuban and Puerto Rican earnings in the tax base does not constitute a "material part" of such taxes. Consequently, we conclude that these State taxes are in their entirety ">*202 definitely related to domestic source income, and an allocation under section 862(b) is unwarranted.

As we have indicated, petitioner treated its Cuban and Puerto Rican stores on the same basis as the approximately 2,000 stores within the United States in allocating a portion of petitioner's executive office expense and other general expenses to such stores for services rendered. The evidence shows that the compensation of petitioner's store managers was based upon the profits generated by the individual store. It would appear therefore that the method of expenditure allocation adopted by petitioner was motivated solely by sound business considerations. It was consistently applied and there is nothing in the record to suggest that the allocations actually made by petitioner in the normal course of its business operations were unreasonable. Thus, we see no reason for disturbing the consistent and reasonable allocations already made by the petitioner. See sec. 1.861-8(a)(4)(ii), Proposed Income Tax Regs.

Respondent has also made an allocation of interest expense to the income received by petitioner from its Puerto Rican stores. Agent Pliskow's reasons for making this adjustment may ">*203 be summarized as follows: (1) Petitioner, in inaugurating operations in Puerto Rico in 1957 and continuing into 1958 and 1959, supplied the Puerto Rican operation with inventory, cash, and fixed assets; (2) petitioner did not charge its Puerto Rican stores for these advances; (3) during this period petitioner was borrowing money at 5-percent interest; and (4) it was, consequently, necessary to make an allocation to income from Puerto Rican stores representing an interest charge which was computed ">*1272 at 5 percent of the net advances made by petitioner to its Puerto Rican operations. From testimony given by Agent Pliskow before this Court, it is clear that respondent does not rely upon either section 482 or section 483¹¹ as authority for this interest expense allocation, but instead relies solely upon section 862(b) and the applicable underlying regulations in support thereof.

In a memorandum report submitted to the audit division ">*204 of the Internal Revenue Service, Agent Pliskow particularly relies upon the proposed regulations under section 861 for the proposition that the interest expense item at issue is definitely related to the gross income earned by petitioner's Puerto Rican branch. To sustain this position, it was incumbent upon the respondent to show by a preponderance of the evidence that such interest expense was incurred as a result of, or incident to, the income-producing activities of the Puerto Rican branch operation. Sec. 1.861-8(a)(3)(i), Proposed Income Tax Regs. We conclude that respondent has failed to carry his burden of proof with respect to this item. He has not introduced any evidence that the money borrowed by petitioner at the rate of 5 percent during this period was in any way connected with the Puerto Rican stores. Indeed, Agent Pliskow frankly admitted that he was unable to link any specific borrowings by petitioner to the advances made to the Puerto Rican branch or otherwise to the income-producing activities of that branch. Thus, in our view respondent has failed to establish a sufficient nexus between the interest expense item and the income earned by the Puerto Rican stores ">*205 that would warrant an allocation under section 862(b).

Respondent cites 50 T.C. 710">Erich O. Grunebaum, supra;South Porto Rico Sugar Co., 2 T.C. 738">2 T.C. 738 (1943); and International Standard Electric Corporation, 1 T.C. 1153">1 T.C. 1153 (1943), affirmed on this issue 144 F.2d 487 (C.A. 2, 1944), to support the allocation of petitioner's expenditures to the income received from the foreign subsidiaries. We find these cases to be readily distinguishable on their facts. In the above-cited cases, the deduction items in question were not definitely related to any item or class of income, and therefore, were properly apportioned between domestic and foreign source income. In contrast, in the instant case the deductions at issue are definitely related to petitioner's domestic source income, thereby obviating any need for an allocation between domestic and foreign source income.

In view of the foregoing, we hold that the allocations made by respondent are not required under section 862(b) and the applicable ">*1273 regulations, and consequently, petitioner's computation of the per country limitation for foreign tax credit purposes is hereby sustained. Accordingly,

Decisions will be entered under Rule 50.

---

Footnotes

• 1. All statutory references will be to the 1954 Internal Revenue Code↩, as amended, unless otherwise noted.

• 1. Other than interest on U.S. obligations.↩

• 2. From the sale of properties.

• 1. Reflects a concession made by respondent of a $ 1,000 item originally allocated to Puerto Rican stores in 1957.

• 1. Since dividend income from England and Germany was included in the base on which some States based their tax, thus increasing such tax, respondent contends that the portion of such taxes attributable to foreign dividends should be allocated to such dividends.↩

• 2. SEC. 901. TAXES OF FOREIGN COUNTRIES AND OF POSSESSIONS OF UNITED STATES.

  (a) Allowance of Credit. -- If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under section 902↩ * * *

• 3. SEC. 902. CREDIT FOR CORPORATE STOCKHOLDER IN FOREIGN CORPORATION.

  (a) Treatment of Taxes Paid by Foreign Corporation. -- For purposes of this subpart, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall --

  (1) to the extent such dividends are paid by such foreign corporation out of accumulated profits (as defined in subsection (c)(1)(A)) of a year for which such foreign corporation is not a less developed country corporation, be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States on or with respect to such accumulated profits, which the amount of such dividends (determined without regard to section 78) bears to the amount of such accumulated profits in excess of such income, war profits, and excess profits taxes (other than those deemed paid); and

• 4. Schedule A

  1. Tax under this Schedule shall be charged in respect of the property in all lands, tenements, hereditaments and heritages in the United Kingdom capable of actual occupation, for every twenty shillings of the annual value thereof:

  * * * *

  2. The annual value for the purposes of this Schedule shall, in the case of all lands, tenements, hereditaments or heritages, of whatever nature and for whatever purpose occupied or enjoyed, and of whatever value, be understood to be --

  (a) if they are let at a rack rent and the amount of that rent has been fixed by agreement commencing within the period of seven years preceding the fifth day of April next before the time of making the assessment, the amount of the rent by the year at which they are let; or

  (b) if they are not let at a rack rent so fixed, then the rack rent at which they are worth to be let by the year:

  Provided that where the annual value of any property is to be determined as for year preceding a year of revaluation, this paragraph shall have effect as if the seven years referred to in sub-paragraph (a) thereof were the seven years ending immediately before the commencement of the said preceding year.

• 5. In 1960, the Code was amended to provide an alternative limitation (known as the overall limitation) to be applied in lieu of the per country limitation at the election of the taxpayer. See sec. 904(a)(2), I.R.C. 1954; sec. 1.904-1(b), Income Tax Regs.; and S. Rept. No. 1393, 86th Cong., 2d Sess., 1960-2 C.B. 874↩.

• 6. Agent Pliskow testified that he did not rely upon sec. 482 in allocating the expenditures in question to petitioner's foreign subsidiaries. Likewise, respondent does not cite sec. 482 on brief in support of such allocation.↩

• 7. In Treas. Dept. release F-1217 dated Apr. 15, 1968, it was announced that the proposed regulations under sec. 861 would "continue in effect under notice of proposed rule making and will be given further consideration before final action is taken thereon." Furthermore, Rev. Rul. 69-121, 1969-1 C.B. 194, states that "further consideration is being given to the proposed regulations under section 861, * * *" and "The general question of the allocation of expenses, losses, and other deductions to items of gross income is under study."

• 8. The parties stipulated that the only dividends included in petitioner's tax base in order to compute the North Carolina tax were dividends from petitioner's Canadian subsidiary. Respondent's reference to the North Carolina taxes appears to be unintentional inasmuch as Agent Pliskow's report concludes that no adjustments are warranted with respect to the dividend income petitioner received from its Canadian subsidiary.↩

• 9. Respondent's allocation of the State taxes in question, which is based upon figures supplied by petitioner to Agent Pliskow, shows the increment resulting from the inclusion of the dividend income at issue in the tax base to be considerably greater than 5 percent. We are uncertain as to the basis for the conflict between these figures and the computation reflected on the various State tax returns. Under any circumstances, respondent has failed to carry his burden of proof that his method of allocation was reasonable.

• 10. These include a resolution adopted by petitioner's board of directors to the effect that the retirement rule for executives of the British subsidiary be applied without exception (1955); authorization by the board of directors for loans to be made to the German subsidiary (1957, 1958, and 1959); authorization by the board of directors for an increase in the capital stock of the German subsidiary (1958); agreements reached concerning the payment of dividends by the German subsidiary (1958, 1959); and a few other instances in which petitioner's top executives gave some general consideration to the desired economic trends of the foreign subsidiaries.↩

• 11. Sec. 483, I.R.C. 1954↩, which in effect imputes interest where a deferred-payment contract for the sale or exchange of property fails to provide therefor, does not appear to be applicable, and in any event, was not in effect during the years involved herein.