internal_revenue_service national_office technical_advice_memorandum date number release date case mis no tam-121094-00 cc intl index uil no team manager taxpayer’s name taxpayer’s address taxpayer’s identification no years involved dates of conferences legend corp a corp a-fsc date industry a possession a tax_year tax_year tax_year issue in determining the foreign_sales_corporation fsc commission payable by corp a to corp a-fsc whether the taxpayer may compute the overall profit percentage opp under temp sec_1 b -1t c of the marginal_costing rules for a tam-121094-00 product by using the opp for the product or product line grouping in which the product is included if with respect to other products in the same product line the taxpayer uses an opp determined at a different overlapping level of the product line hierarchy conclusion this method of grouping transactions in computing the opp under the fsc marginal_costing rules is not permissible because it involves inclusion of a product in more than one product group in violation of the second sentence of temp sec_1 b -1t b ii facts corp a is a domestic_corporation that files a consolidated federal_income_tax return with various wholly-owned domestic subsidiaries corp a-fsc is a wholly-owned subsidiary of corp a incorporated in possession a on date for tax_year sec_1 and corp a-fsc had in place a valid election to be treated as a foreign_sales_corporation fsc pursuant to sec_922 and sec_927 of the internal_revenue_code and in all other respects continuously maintained its status as a fsc as defined in sec_922 corp a and certain of its domestic subsidiaries are engaged in the manufacture and worldwide sale of products in industry a and are related suppliers with respect to corp a-fsc within the meaning of temp sec_1_927_d_-2t for purposes of this memorandum corp a and the other related suppliers are referred to collectively as corp a corp a-fsc acts as commission agent for export sales of corp a which pays corp a-fsc a commission equal to the maximum amount permitted under the administrative pricing provisions of sec_925 the products sold by corp a for export are export_property within the meaning of sec_927 the gross_receipts derived from corp a's export sales are foreign_trading_gross_receipts within the meaning of sec_924 in the original income_tax returns filed for tax_year sec_1 and corp a and corp a-fsc collectively taxpayer elected pursuant to sec_927 and temp sec_1 a -1t c i to group some of its export transactions in applying the administrative pricing rules of sec_925 in amended returns timely filed pursuant to temp sec_1 a -1t e and a -1t c i as amended by t d c b taxpayer redetermined some of its fsc commissions using the combined taxable_income cti method under sec_925 and sec_925 for the full costing cti method under sec_925 the commission was determined entirely on a transaction-by-transaction basis however with respect to those products for which taxpayer chose to apply the marginal_costing tam-121094-00 rules under sec_925 taxpayer grouped transactions for purposes of computing the overall profit percentage opp pursuant to temp sec_1 b -1t c at issue is the methodology used for this opp grouping corp a’s products typically are categorized into a multi-tiered tree or hierarchy of product lines as shown in diagram abcdefgh abcd efgh ab cd ef gh a b c d e f g h diagram the broadest product line abcdefgh comprises two narrower product lines abcd and efgh product line abcd in turn comprises two narrower product lines ab and cd while product line efgh comprises product lines ef and gh each of these narrower product lines comprise the various products for example product line ab includes products a and b a product constitutes the narrowest level at which transactions are grouped taxpayer represents that all products and product lines are properly determined in accordance with recognized trade or industry usage within the meaning of temp sec_1 a -1t c ii in grouping for opp purposes taxpayer first computes an opp for each product and product line level a typical example is shown in diagram taxpayer computes an opp of for product a by grouping all transactions in that product taxpayer also computes an opp of for product line ab grouping all transactions in all products in that product line including products a and b the opp for product line ab is less than the opp for product a because the profitability of product b which has a lesser individual opp of is averaged with the profitability of product a to arrive at the opp for product line ab similarly working up the product line tree taxpayer computes an opp of for the broader product line abcd grouping all product lines under that product line including product lines ab and cd finally taxpayer computes an opp of for the broadest product line abcdefgh grouping all product lines under it including abcd and efgh tam-121094-00 taxpayer then selects the opp grouping to be used in its marginal_costing administrative price fsc commission with respect to the transactions in each product in making this selection for a product taxpayer chooses the greatest of the opps for all the levels of the product lines that comprise that product for example for product a taxpayer chooses the opp computed separately for that product since that opp is greater than the opp computed for product line ab product line abcd or product line abcdefgh by contrast in the case of product b the opp computed for the abcd product line is greater than that computed for product b separately or at the level of product line ab or product line abcdefgh therefore taxpayer uses the opp computed for the entire product line abcd grouping as the operative opp to be used in determining the fsc commission with respect to the transactions in product b notwithstanding that such grouping overlaps the product a grouping used for opp purposes for product a law for tax_year sec_1 and a foreign_corporation that properly elects fsc treatment pursuant to sec_922 and sec_927 may under sec_921 exclude from its taxable_income portions of its foreign_trade_income derived from foreign_trading_gross_receipts under sec_924 and temp sec_1 a - 1t b foreign_trading_gross_receipts of a fsc generally include gross_receipts from the sale of export_property as defined in sec_927 by either the fsc or any principal for whom the fsc acts as a commission agent the commission payable to the fsc by a related_supplier may be determined under the administrative pricing rules of sec_925 which include the combined taxable_income cti method under sec_925 under this method the fsc commission is computed by reference to full costing cti or in the alternative marginal_costing cti pursuant to sec_925 sec_927 provides b grouping of transactions -- to the extent provided in regulations any provision of this subpart which but for this subparagraph would be applied on a transaction-by-transaction basis may be applied by the taxpayer on the basis of groups of transactions based on product lines or recognized industry or trade usage such regulations may permit different groupings for different purposes temp sec_1 a -1t c provides in pertinent part grouping transactions i the determinations under this section are to be made on a transaction-by-transaction basis however at the annual choice made by the related_supplier if the administrative pricing methods are used some or all of these determinations may be made on the basis of groups consisting of products or product lines tam-121094-00 ii a determination by the related_supplier as to a product or a product line will be accepted by a district_director if such determination conforms to either of the following standards recognized trade or industry usage or the two-digit major groups or any inferior classifications or combinations thereof within a major group of the standard industrial classification as prepared by the statistical policy division of the office of management and budget executive office of the president a product shall be included in only one product line if a product otherwise falls within more than one product line classification iii a choice by the related_supplier to group transactions for a taxable_year on a product or product line basis shall apply to all transactions with respect to that product or product line consummated during the taxable_year however the choice of a product or product line grouping applies only to transactions covered by the grouping and as to transactions not encompassed by the grouping the determinations are to be made on a transaction-by-transaction basis for example the related_supplier may choose a product grouping with respect to one product and use the transaction-by-transaction method for another product within the same taxable_year emphasis added sec_925 provides b rules for marginal_costing -- the secretary shall prescribe regulations setting forth -- rules for the allocation of expenditures in computing combined taxable_income under subsection a in those cases where a fsc is seeking to establish or maintain a market for export_property temp sec_1 b -1t provides in pertinent part a in general this section prescribes the marginal_costing rules authorized by sec_925 if under paragraph c of this section a fsc is treated for its taxable_year as seeking to establish or maintain a foreign market for sales of an item product or product line of export_property from which foreign_trading_gross_receipts are derived the this rule is illustrated in example of temp sec_1 a -1t f tam-121094-00 marginal_costing rules prescribed in paragraph b of this section may be applied at the related supplier’s election to compute combined taxable_income of the fsc and related_supplier derived from those sales b marginal_costing rules -- in general marginal_costing is a method under which only direct production_costs of producing a particular item product or product line are taken into account for purposes of computing the combined taxable_income of the fsc and its related_supplier under sec_925 overall profit percentage limitation under marginal_costing the combined taxable_income of the fsc and its related_supplier may not exceed the overall profit percentage determined under paragraph c of this section multiplied by the fsc’s foreign_trading_gross_receipts if the fsc is the principal on the sale or the related supplier’s gross_receipts if the fsc is a commission agent from the sale of export_property grouping of transactions i in general for purposes of this section an item product or product line is the item or group consisting of the product or product line pursuant to sec_1 a -1t c used by the taxpayer for purposes of applying the full costing combined taxable_income method of sec_1 a -1t c and ii however for purposes of determining the overall profit percentage under paragraph c of this section any product or product line grouping permissible under sec_1 a -1t c may be used at the annual choice of the fsc even though it may not be the same item or grouping referred to in the above subdivision i of this paragraph as long as the grouping chosen for determining the overall profit percentage is at least as broad as the grouping referred to in the above subdivision i of this paragraph a product may be included for this purpose however in only one product group even though under the grouping rules it would otherwise fall in more than one group thus the marginal_costing rules will not apply with respect to any regrouping if the regrouping does not include any product or products that was included in the group for purposes of the full costing method c definitions -- establishing or maintaining a foreign market a fsc shall be treated for its taxable_year as seeking to establish or maintain a foreign market with respect to sales of an item product or product line of export_property from which foreign_trading_gross_receipts are derived if the combined taxable_income computed under paragraph tam-121094-00 b of this section is greater than the full costing combined taxable_income overall profit percentage i for purposes of this section the overall profit percentage for a taxable_year of the fsc for a product or product line is the percentage which -- a the combined taxable_income of the fsc and its related_supplier from the sale of export_property plus all other taxable_income of its related_supplier from all sales domestic and foreign of such product or product line during the fsc’s taxable_year computed under the full costing method is of related_supplier from all sales of the product or product line b the total gross_receipts of the fsc and ii at the annual option of the related_supplier the overall profit percentage for the fsc’s taxable_year for all products and product lines may be determined by aggregating the amounts described in subdivision i a and b of this paragraph of the fsc and all domestic members of the controlled_group as defined in sec_927 and sec_1 a -1t h of which the fsc is a member for the fsc’s taxable_year and for taxable years of the members ending with or within the fsc’s taxable_year emphasis added prior to the enactment of the fsc provisions certain export transactions were subject_to the domestic_international_sales_corporation disc regime of sections which contained administrative pricing rules similar to the corresponding fsc provisions the legislative_history of the fsc regime states in general where the provisions of the bill are identical or substantially_similar to the disc provisions under present law the committee intends that rules comparable to the rules in regulations issued under those provisions will be applied to the fsc s prt no 98th cong 2d sess vol i with respect to grouping transactions of a disc for full costing cti purposes the first three paragraphs of sec_1_994-1 provide grouping transactions i generally the determinations under this section are to be made on a transaction-by-transaction basis however at the annual choice of the taxpayer some or all of these tam-121094-00 determinations may be made on the basis of groups consisting of products or product lines ii a determination by a taxpayer as to a product or a product line will be accepted by a district_director if such determination conforms to any one of the following standards a a recognized industry or trade usage or b the two-digit major groups or any inferior classifications or combinations thereof within a major group of the standard industrial classification as prepared by the statistical policy division of the office of management and budget executive office of the president iii a choice by the related_supplier to group transactions for a taxable_year on a product or product line basis shall apply to all transactions with respect to that product or product line consummated during the taxable_year however the choice of a product or product line grouping applies only to transactions covered by the grouping and as to transactions not encompassed by the grouping the determinations are made on a transaction-by-transaction basis for example the taxpayer may choose a product grouping with respect to one product and use the transaction-by-transaction method for another product within the same taxable_year with respect to grouping transactions of a disc for marginal_costing cti purposes sec_1_994-2 provides grouping of transactions i in general for purposes of this section an item product or product line is the item or group consisting of the product or product line pursuant to sec_1_994-1 used by the taxpayer for purposes of applying the intercompany_pricing_rules of sec_1_994-1 ii however for purposes of determining the overall profit percentage under subparagraph of this paragraph any product or product line grouping permissible under sec_1_994-1 may be used at the annual choice of the taxpayer even though it may not be the same item or grouping referred to in subdivision i of this paragraph as long as the grouping chosen for determining the overall profit percentage is at least as broad as the grouping referred to in such subdivision i the technical memorandum accompanying the treasury_decision issuing the disc administrating pricing regulations states in pertinent part sec_1_994-2 tam-121094-00 paragraph c provides the rules with respect to grouping of transactions for purposes of marginal_costing the groups consisting of products or product lines adopted by the related_supplier under sec_1 c for purposes of applying the intercompany_pricing_rules of sec_1 must also be used for purposes of applying the marginal_costing rules items not grouped under sec_1_994-1 should not be grouped for marginal_costing purposes however for purposes of determining the overall profit percentage under paragraph c the option is given to adopt broader groups of products and product lines than were adopted under sec_1_994-1 this liberalization of the grouping rule is intended to make simpler and easier the computation of the overall profit percentage limitation also if broader groups may be adopted marginal_costing may be permitted with respect to some items products or product lines for which marginal_costing would not otherwise be available this approach is consistent with the theory of sec_1_994-1 which is to give taxpayers maximum flexibility in determining groups of products and product lines in order to obtain maximum benefit from the intercompany_pricing_rules and to simplify computations tech mem t d tm lexi sec_30 pincite date analysis at issue is whether the opp grouping method adopted by taxpayer ie the selection of overlapping opp groupings at different levels of the product line hierarchy for different products complies with the restriction stated in the second sentence of temp sec_1 b -1t b ii a product may be included for this purpose however in only one product group even though under the grouping rules it would otherwise fall in more than one group this restriction prohibits product groups from being counted more than once in a taxpayer’s opp computations thus we refer to the restriction as a prohibition against double inclusion or the double-inclusion prohibition in diagram for example assuming taxpayer receives the benefit of product a’s own relatively large product-level opp with respect to product a we must determine whether taxpayer's use of the opp for product line abcd with respect to product b involves a double counting of the opp for product a in violation of the double-inclusion prohibition taxpayer defines the term product group in a manner described below such that taxpayer's opp grouping methodology does not violate the double-inclusion prohibition we have considered taxpayer's arguments but conclude that the prohibition applies to taxpayer’s opp grouping methodology as well tam-121094-00 temp sec_1 b -1t b governs grouping for marginal_costing cti purposes subdivision i of this paragraph sets forth a general_rule that an item product or product line for marginal_costing purposes must conform with the item or group consisting of the product or product line used for full costing purposes this initial language expressly imports the product or product line concept as the model for grouping to be used in marginal_costing and additionally requires the marginal_costing group to be congruent with the full costing group as a textual matter this language internally defines a group as a product or product line group consisting of the product or product line consistent with the usage in temp sec_1 a - 1t c i groups consisting of products or product lines subdivision ii provides an exception to the required congruence with the full costing group for purposes of determining the opp limitation on marginal_costing cti the first sentence of subdivision ii provides that the opp item or grouping need not be the same as its full costing counterpart with two qualifications first it must be a product or product line grouping permissible under the full costing grouping rules at temp sec_1 a -1t c second it must be at least as broad as the full costing grouping as imported for marginal_costing purposes under subdivision i again as a textual matter this sentence initially refers to any product or product line grouping and then repeatedly uses grouping as the shorthand for this usage the second sentence of temp sec_1 b -1t b ii the double- inclusion prohibition here at issue states a product may be included for this purpose however in only one product group even though under the grouping rules it would otherwise fall in more than one group because this sentence is qualified by however we interpret the sentence as a qualification on the first sentence therefore the term product group refers to the grouping consisting of a product or product line that has been selected pursuant to the first sentence as the grouping used for the opp computation the third sentence of temp sec_1 b -1t b ii states thus the marginal_costing rules will not apply with respect to any regrouping if the regrouping does not include any product or products that was included in the group for purposes of the full costing method this sentence is linked to the preceding sentences by thus and serves to clarify the first sentence by pointing out that if a grouping is at least as broad as the full costing grouping it will necessarily include all products that were included in the narrower grouping once again as a textual matter it is plain that the terms group and regrouping like the terms group grouping and product group in the other two sentences are used interchangeably to be synonymous with the phrase group consisting of the product or product line in temp sec_1 b -1t b i and its antecedent in temp sec_1 a -1t c i the textual linkage to the concept of groups constituting products or product lines is also reflected in the specific restrictions on opp grouping which correspond to counterparts under full costing and adapt the full costing restrictions to the opp tam-121094-00 context thus the first sentence of temp sec_1 b -1t b ii clarifies that opp groupings generally follow the groupings used for full costing purposes but may be different as long as they would be permissible under the full costing standards and are at least as broad as the full costing groupings the second sentence is the opp counterpart to the double-inclusion prohibition of temp sec_1 a -1t c ii which states a product shall be included in only one product line if a product otherwise falls within more than one product line classification the opp version uses the term product group instead of product line but for the reasons stated above and following we find that product group means a product or product line grouping permissible for full costing grouping purposes and used for opp grouping purposes finally the third sentence of temp sec_1 b -1t b ii is the opp counterpart to the full-inclusion rule_of temp sec_1 a -1t c iii grouping shall apply to all transactions in the selected product or product line the opp version of this sentence grouping fails if it does not include any product or products included for full costing purposes is slightly modified to clarify that the averaging computations of the opp inherently involve grouping of entire products rather than individual transactions taxpayer’s opp grouping methodology insofar as it involves overlapping groupings violates the opp double inclusion provision in the second sentence of temp sec_1 b -1t b ii the use of opps selected from different levels in the product line hierarchy necessarily results in the inclusion of a product in more than one grouping whenever the levels are within the same product line and thus overlap in diagram such opp grouping would include product a in both the opp grouping of transactions consisting of product a and with respect to product b the opp grouping consisting of product line abcd in the product line hierarchy product a falls within both of these levels and could be grouped in either one of them for example the individual product-level opps could be used for opp grouping with respect to each of products a b c and d or the opp determined at the level of product line abcd could be used with respect to each of the four products in the latter case none of the products would violate the double-inclusion prohibition because each product would be used in only one opp grouping -- abcd however the double- inclusion prohibition prevents any one of the products from being grouped at both levels in determining the total fsc commission because then it would be used in more than one opp computation in determining the fsc commission for the taxable_year if taxpayer uses the opp determined at the product a level with respect to product a taxpayer is prohibited from using the optimal opp determined at the product line abcd level with respect to product b otherwise product a would be used in a second opp grouping that of product line abcd taxpayer maintains that product group in the second sentence of temp sec_1 b -1t b ii means only a grouping not constituting a product or product tam-121094-00 line within the meaning of temp sec_1 a -1 c taxpayer acknowledges that using the opp of the product with respect to the product itself and in a product group so defined would be impermissible because it would violate the double-inclusion prohibition as in technical_advice_memorandum date however taxpayer's methodology involves only grouping on a product or product line basis consequently under taxpayer's narrow interpretation of product group taxpayer's methodology is not within the scope of the double-inclusion prohibition in temp sec_1 b -1t b ii for example in diagram taxpayer does not dispute that once product a is used in the product line hierarchy whether grouped alone or as part of product line ab product line abcd or product line abcdefgh product a could not then be grouped with product f in determining the opp for f we refer to this below as the af example taxpayer maintains however that the opp for the broadest product line abcdefgh could be used as the opp for f we have considered individually and in combination the arguments that taxpayer advances in support of its position but we find them flawed taxpayer maintains that in the absence of a definition of the term product group in the second sentence of temp sec_1 b -1t b ii the term must mean something different from the term product or product line used in the corresponding full costing rule in temp sec_1 b -1t b ii we disagree first there is nothing inherent in the plain meaning of the words product group that is inconsistent with either a product or a product line a product is a group of transactions so product group is susceptible to the meaning of a grouping that consists of a product it is equally susceptible to being defined as a product line a product line is a group of products and product group is a natural contraction of group of products second and more important as discussed in detail above a textual analysis of the regulations demonstrates that product group merely serves as the opp counterpart to the product or product line language in full costing and is one in a series of correspondences between the requirements of the opp grouping regulations and the requirements of the full costing grouping regulations as earlier indicated throughout the text of the opp regulations the terms group grouping and regrouping are consistently used as interchangeable equivalents of group consisting of the product or product line the term product group must be similarly construed as a matter of textual consistency moreover taxpayer has not proffered a coherent definition of this key regulatory term taxpayer posits that a product group is a grouping not constituting a product or because the grouped products do not constitute a product line in accordance with the sic code or recognized trade or industry usage standard of temp sec_1 a -1t c ii as adopted by the first sentence of temp sec_1 b -1t b ii the grouping would additionally fail for that reason as in tam tam-121094-00 product line within the meaning of temp sec_1 a -1t c in the af example the first opp grouping selected used with respect to product a is that of product a alone a grouping that is a product cannot be a product group as defined by taxpayer the second opp grouping selected used with respect to product f is that of af which is a product group as defined by taxpayer product a has been used in one product group as defined however the second sentence of temp sec_1 b -1t b ii prohibits inclusion of a product in more than one product group taxpayer's own example does not fit taxpayer's proposed definition one could possibly refine the definition to better fit the kind of grouping that taxpayer believes is caught by the double-inclusion prohibition eg a product group is either i a product or ii a grouping of products not constituting a product or product line but this would depart farther from the plain language and textual analysis of the regulations we conclude contrary to taxpayer's position that the regulations do not create a product group paradigm for opp purposes separate from the product line concept that prevails in cti determinations in support of its narrow interpretation of product group taxpayer asserts that the opp regulations expressly allow double inclusion within the product line hierarchy because grouping is permitted at any level in the product line hierarchy subject only to the restriction that the opp grouping be at least as broad as the full costing cti grouping this proposition confuses the ability to choose among multiple overlapping levels in arriving at the operative grouping with the ability to use more than one overlapping operative grouping simultaneously the operative grouping to which a regulatory restriction applies is the group that the taxpayer ultimately uses to make the relevant transfer_pricing determination rather than any tentative grouping that the taxpayer may consider as an intermediate step in the process of arriving at the operative grouping with respect to the opp limitation under marginal_costing the relevant determination is the computation of the opp so the operative grouping is the opp grouping under temp sec_1 b -1t b ii the plain language of the first sentence states that the requirements set forth apply to the grouping chosen for determining the opp and the second sentence confirms that the double-inclusion prohibition applies for this purpose this operative grouping is separate and distinct from the grouping for full costing cti purposes under temp sec_1 a - 1t c or the grouping for marginal_costing cti purposes prior to application of the opp limitation under temp sec_1 b -1t b i a taxpayer may refer to these cti groupings as tentative possibilities in choosing the operative opp grouping but they should not be confused with the operative opp grouping itself thus we find that this operative opp grouping is the product group referred to in the double-inclusion prohibition in the context of the provision in which the term appears and as noted in our textual analysis above we find that a product group is the operative grouping used by the taxpayer for opp purposes as distinct from grouping under temp sec_1 b -1t b i which adopts full costing cti groups for marginal_costing purposes whether at the product or product line level the tam-121094-00 double-inclusion prohibition in the second sentence of temp sec_1 b - 1t b ii prevents inclusion of a product in overlapping operative opp groupings our interpretation of product group is supported by the analogous double- inclusion provision for full costing cti purposes under temp sec_1 a - 1t c ii that provision permits inclusion of a product in only one product line taxpayer does not dispute that the term product line refers to the operative grouping for purposes of the relevant transfer_pricing determination -- there full costing cti the term product group serves the identical function with respect to opp grouping it describes the operative grouping and has no other special meaning taxpayer asserts that its definition of product group captures a distinction between its method of grouping within the product line hierarchy used for cti purposes which taxpayer calls vertical opp grouping and the grouping of products in a way that does not constitute a product line which taxpayer calls horizontal grouping however the two types of grouping posited by taxpayer have the same characteristic of overlapping groupings resulting in the same mathematical effect in both cases a high-profit product a in the examples is double-counted as both the source of a large opp with respect to its own transactions and an enhancement to the opp of a product with lower profitability b in the example of taxpayer's methodology and f in the af example this kind of distortion is targeted by the plain language of the second sentence of temp sec_1 b -1t b ii taxpayer observes that horizontal grouping is prone to one kind of abuse and manipulation absent in vertical grouping in horizontal grouping a taxpayer may potentially form a large number of mathematically advantageous groups by mixing and matching unlike products as in tam by contrast taxpayer's methodology confines its opp groupings to the established product line hierarchy taxpayer thus characterizes its own methodology as more natural than the horizontal variety of opp grouping and argues that this distinction justifies application of the double-inclusion prohibition to only the unnatural methodology the double-inclusion prohibition is concerned with the distortive mathematical effect of overlapping groupings that result in double counting it appears possible that a natural product line hierarchy in a given case could be manipulated to yield a mathematical distortion similar in magnitude to the mathematical effect of an unnatural grouping across hierarchical lines however we need not speculate the double-inclusion prohibition by its terms abides no double counting we conclude that the term product group simply means the operative opp grouping irrespective of whether such opp grouping is horizontal or vertical taxpayer asserts that a prohibition on opp groupings within the product line hierarchy is inconsistent with temp sec_1 b -1t c ii which permits taxpayers in a controlled_group as defined in sec_927 and temp treas reg tam-121094-00 sec_1 a -1t h to aggregate the worldwide profits and worldwide receipts of all such taxpayers in computing the numerator and denominator of the operative opp we disagree this aggregation rule is not structurally or analytically part of the grouping rules the aggregation option simply permits taxpayers in a controlled_group to treat all transactions in a qualifying product or product line as entered into by a single entity for opp computation purposes the opp rules including the grouping provisions of temp sec_1 b -1t b apply to the combined product array of the controlled entities accordingly the second sentence of temp sec_1 b - 1t b ii would prohibit the use of overlapping groupings with respect to different products in that array taxpayer points to the absence of a double-inclusion prohibition in sec_1_994-1 and sec_1_994-2 the corresponding disc grouping regulations and notes that such absence was confirmed by a technical_advice_memorandum indeed tam date found that once the taxpayer met the requirement that opp grouping be at least as broad as grouping for full costing cti purposes t here are no other restrictions on the allowable grouping the service had similarly ruled favorably on overlapping opp grouping for different products in tam date taxpayer further notes that the legislative_history of the fsc provisions states that i n general where the provisions of the bill are identical or substantially_similar to the disc provisions under present law the committee intends that rules comparable to the rules in regulations issued under those provisions will be applied to the fsc s prt no 98th cong 2d sess vol i in light of this background taxpayer maintains that the double-inclusion prohibition in temp sec_1 b -1t b ii must be construed narrowly so as not to apply to taxpayer's methodology of grouping at different overlapping levels within the product line hierarchy taxpayer suggests in this regard that had treasury and the service intended to change the taxpayer-favorable disc result with respect to opp grouping within the product line hierarchy the preamble to the fsc regulations t d 1987_1_cb_184 would have expressly indicated that such grouping was within the scope of the fsc prohibition on double inclusion we do not agree that this background supports taxpayer's position to the contrary we believe that the history of this issue in transition under the disc and fsc regimes is inconsistent with taxpayer's interpretation although the legislative_history contemplates fsc regulations that are i n general comparable to the disc the precise issue in this ruling was not grouping at different overlapping levels for marginal_costing opp purposes but rather grouping at one level for marginal_costing opp purposes and at a different overlapping level to determine an opp for purposes of the special no-loss rule_of sec_1_994-1 this earlier ruling too involved the special opp under sec_1 e rather than the marginal_costing opp tam-121094-00 regulations nothing mandates that the fsc and disc regulations be interpreted identically in all particulars the explicit double-inclusion prohibition in temp sec_1 b -1t b ii as well as the treatment of the issue in technical_advice reflects that treasury and the service were aware that there was no such restriction in the disc regime and affirmatively intended to change the disc result moreover absent any basis in the regulations for distinguishing between taxpayer's methodology and any other yielding the same mathematical result the explicit fsc prohibition cannot be said to have been limited to only other methods of overlapping opp grouping no inference can be drawn from the fact that the preamble to the fsc regulations did not focus in detail on particular restrictions adopted in a comprehensive set of regulations a preamble is a general summary and overview its silence on the purpose of the second sentence is inapposite to the interpretation of the sentence taxpayer correctly observes that the administrative pricing rules in general and the marginal_costing and opp grouping rules in particular afford taxpayers certain choices and flexibility in determining fsc treatment see tech mem t d tm lexi sec_30 pincite date accompanying disc marginal_costing regulations however taxpayer erroneously extrapolates from these general statements of policy to a position that the fsc provisions must be construed to permit unrestricted flexibility the flexibility afforded in the administrative pricing rules is not unbridled the opp limitation itself is a significant restriction on the marginal_costing method taxpayer's argument ignores well-established principles of statutory construction the fsc provisions in general and in particular the marginal_costing and grouping rules enabled by sec_925 and sec_927 effectively confer a partial exemption of income the tax_court has held that grouping issues under the disc regime are subject_to the doctrine_of narrow construction of tax exemption provisions in napp systems inc v commissioner tcmemo_1993_196 the court this doctrine has been consistently applied in a variety of tax cases by the supreme court and circuit courts of appeal see 504_us_229 title vii back-pay award held not within scope of sec_104 exclusion of damages for personal injury exclusions from income must be narrowly construed 489_us_726 in construing provisions such as sec_356 in which a general statement of policy is qualified by an exception we usually read the exception narrowly in order to preserve the primary operation of the provision 356_us_260 rate exception for capital_gain has always been narrowly construed so as to protect the revenue against artful devices 350_us_46 since capital_gain treatment is an exception from the normal_tax requirements of the internal_revenue_code the definition of a capital_asset must be continued tam-121094-00 held invalid a country-by-country basis of grouping finding that since the regulation results in a tax deduction we are required to construe it narrowly in 94_tc_919 aff'd 955_f2d_1037 6th cir the court rejected a taxpayer’s argument that the opp regulations must be interpreted in every case to maximize the benefit of marginal_costing the court held petitioner's argument is essentially that if its method produces a result in harmony with the general regulatory purpose it is correct s uch end justifies the means argument must fail where the means contravenes the continued narrowly applied 336_us_28 the income taxed is described in sweeping terms and should be broadly construed in accordance with an obvious purpose to tax income comprehensively the exemptions on the other hand are specifically stated and should be construed with restraint in the light of the same policy 292_us_435 o nly in exceptional situations clearly defined has there been provision for an allowance for losses suffered in an earlier year 123_f3d_1342 10th cir w e must narrowly construe the 'reasonable cause' exception to sec_6672 liability in order to further the basic purpose of sec_6672 to protect government revenue 86_f3d_1045 11th cir because the terminable property rule is an exception to this general_public policy it should be narrowly construed 914_f2d_586 4th cir defamation damages held not within scope of sec_104 exclusion of damages for personal injury it is a well-recognized even venerable principle that exclusions to income are to be narrowly construed 412_f2d_494 6th cir deferral of gain on residence denied income_tax provisions which exempt taxpayers under given circumstances from paying taxes or as here postponing them are strictly construed 394_f2d_631 6th cir dividend credit denied i t is standard tax law that income deductions and tax_credits are narrowly construed and the taxpayer has the burden of showing he comes within the provision relied upon 364_f2d_38 8th cir income of native american lessee of tribal land not entitled to statutory exemption relating to fee interests exemptions from taxation are matters of legislative grace while here there was no treaty or statute expressly or impliedly exempting such income 324_f2d_702 5th cir this treatment is an exception to the general_rule of taxing all net_income as ordinary_income and as an exception it should be narrowly construed o'gilvie v united_states ustc big_number d kan mot for rec66_f3d_1550 10th cir aff’d 519_us_79 punitive_damages held not within scope of sec_104 exclusion i t is a cardinal rule_of taxation that exclusions to income are to be narrowly construed tam-121094-00 plain language of the regulations w e are unwilling to rewrite the regulation the sixth circuit affirmed stating given the clarity of the opp regulation at issue we are unmoved by the taxpayer’s argument applying the same principle to this case the scope of permitted opp grouping should be narrowly construed as in brown-forman the opp regulation in this case is unambiguous we decline to adopt taxpayer’s interpretation which in effect would rewrite the second sentence of temp sec_1 b -1t b ii had treasury and the service intended to narrow the scope of the double-inclusion prohibition in the very specific way that taxpayer suggests we would expect that explicit language limiting the scope of the prohibition would have been added to the provision as adopted the double-inclusion prohibition is not limited to overlapping opp grouping methodologies not used by taxpayer rather it applies to all overlapping opp grouping methodologies including that used by taxpayer we conclude that in applying the marginal_costing rules under sec_925 to determine corp a's fsc commission for tax_year sec_1 and taxpayer may not compute the opp with respect to a product by using the opp for the product or product line grouping in which the product is included if with respect to other products in the product line the taxpayer determines the opp at a different overlapping level in the product line hierarchy this method of grouping transactions for opp purposes involves inclusion of a product in more than one product group in violation of the second sentence of temp sec_1 b -1t b ii caveats the sole issue addressed by this memorandum is the permissibility of the opp grouping methodology described no opinion is expressed on any other issue including whether any specific product or product line conforms with the requirements of temp sec_1 a -1t c or b -1t b or whether any grouping redetermination was timely filed or otherwise conformed with the procedural requirements of temp sec_1 a -1t c i or a -1t e a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 provides that it may not be used or cited as precedent


department of the treasury washington dc person to contact ---------------- id no ------------------ telephone number ---------------------- refer reply to cc psi b04 - plr-105061-18 date date internal_revenue_service number release date index number --------------------- ---------------------------- ----------------------------- re --------------------------- legend ------------------- ------------------------------------------------- ---------------------------------------------------------------- date grantor_trust -------------------------------------------------------------- child child child child trustee state distribution committee --------------------- ------------------------------- ------------------------ --------------------------- --------------------- ----------- ------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------ dear -------------- this letter responds to your authorized representative’s letter dated date requesting rulings under sec_671 sec_2501 and sec_2514 of the internal_revenue_code facts the facts submitted and representations made are as follows on date grantor created trust grantor will be the only person who transfers assets to trust and all property contributed to trust will be grantor’s separate_property under the law of the plr-105061-18 state in which grantor resides the beneficiaries of trust are grantor child child child and child trustee a private fiduciary is the sole trustee of trust the situs of trust is state the terms of trust are as follows during grantor’s lifetime trustee must distribute such amounts of income and or principal to grantor child child child and child as directed by the distribution committee and or grantor as follows at any time trustee pursuant to the direction of a majority of the distribution committee members with the written consent of grantor shall distribute to any beneficiaries such amounts of the trust’s corpus or income as directed by the distribution committee grantor’s consent power at any time trustee pursuant to the direction of all of the distribution committee members other than grantor shall distribute to any beneficiary such amounts of the net_income or principal as directed by the distribution committee unanimous member power and at any time grantor in a nonfiduciary capacity may but shall not be required to direct trustee to distribute to any one or more beneficiary other than grantor such amounts of the principal including the whole thereof as grantor deems advisable to provide for the health maintenance support and education of said beneficiaries grantor’s sole power the distribution committee may direct that distributions be made equally or unequally and to or for the benefit of any one or more of the beneficiaries of trust to the exclusion of others any net_income not distributed by trustee will be accumulated and added to principal the trustee pursuant to the direction of a majority of the distribution committee members with the written consent of the grantor or pursuant to the direction of all of the distribution committee members other than the grantor shall at any time or times prior to or upon the distribution date distribute to the trustee or trustees of any one or more qualified trusts such amounts of the net_income and or principal of trust including the whole thereof as the distribution committee determines any such distribution shall be added to the principal of such qualified_trust and disposed of in accordance with the terms of such qualified_trust no distribution or transfer may be made to a qualified_trust unless made pursuant to the direction of the distribution committee plr-105061-18 the distribution committee is initially composed of grantor child and child at all times at least two eligible individuals must be members of the distribution committee eligible individuals include all beneficiaries other than grantor who are at least years of age a vacancy on the distribution committee must be filled by the eldest eligible_individual not already serving as a member of the distribution committee if at any time fewer than two eligible individuals are members of the committee the distribution committee shall be deemed not to exist the distribution committee shall cease to exist upon the death of grantor upon grantor’s death trust shall terminate and all of the trust property shall be distributed to such persons corporations or entities other than grantor’s estate grantor’s creditors or the creditors of grantor’s estate as grantor may appoint by will in default of the exercise of this limited power to appoint grantor’s testamentary power the balance of trust will be distributed to grantor’s then living descendants per stirpes if none of grantor’s descendants are living the balance is to be distributed to one or more entitles that qualify for the estate_tax deduction under sec_2055 as the trustee in its sole discretion may choose you have requested the following rulings during the period the distribution committee is serving no portion of the items of income deductions and credits against tax of trust shall be included in computing the taxable_income deductions and credits of grantor under sec_671 the contribution of property to trust by grantor will not be a completed_gift subject_to federal gift_tax any distribution_of_property by the distribution committee from trust to grantor will not be a completed_gift subject_to federal gift_tax by any member of the distribution committee any distribution_of_property by the distribution committee from trust to any beneficiary of trust other than grantor will not be a completed_gift subject_to federal gift_tax by any member of the distribution committee ruling sec_671 provides that where it is specified in subpart e of part i of subchapter_j that the grantor or another person shall be treated as the owner of any portion of a_trust there shall then be included in computing the taxable_income and credits of the grantor or the other person those items of income deductions and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items plr-105061-18 would be taken into account under chapter in computing taxable_income or credits against the tax of an individual sec_672 provides for purposes of subpart e the term adverse_party means any person having a substantial_beneficial_interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust sec_673 through specify the circumstances under which the grantor is treated as the owner of a portion of a_trust sec_673 provides that the grantor shall be treated as the owner of any portion of a_trust in which the grantor has a reversionary_interest in either the corpus or the income therefrom if as of the inception of that portion of the trust the value of such interest exceeds five percent of the value of such portion sec_674 provides in general that the grantor shall be treated as the owner of any portion of a_trust in respect of which the beneficial_enjoyment of the corpus or the income therefrom is subject_to a power of disposition exercisable by the grantor or a nonadverse_party or both without the approval or consent of any adverse_party sec_674 provides that sec_674 shall not apply to the powers described in sec_674 regardless of by whom held sec_674 provides that sec_674 shall not apply to a power exercisable only by will other than a power in the grantor to appoint by will the income of the trust where the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse_party or both without the approval or consent of any adverse_party sec_674 provides that sec_674 shall not apply to a power to distribute corpus to or for a beneficiary provided that the power is limited by a reasonably_definite_standard under sec_675 and applicable regulations the grantor is treated as the owner of any portion of a_trust if under the terms of the trust agreement or circumstances attendant on its operation administrative control is exercisable primarily for the benefit of the grantor rather than the beneficiary of the trust sec_676 provides that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such owner under any other provision of part i subchapter_j chapter where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse_party or both plr-105061-18 sec_677 provides in general that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such owner under sec_674 whose income without the approval or consent of any adverse_party is or in the discretion of the grantor or a nonadverse_party or both may be distributed to the grantor or the grantor’s spouse held or accumulated for future distribution to the grantor or the grantor’s spouse or applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse sec_678 provides that a person other than the grantor shall be treated as the owner of any portion of a_trust with respect to which such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself or such person has previously partially released or otherwise modified such a power and after the release or modification retains such control as would within the principles of inclusive subject a grantor of a_trust to treatment as the owner thereof based solely on the facts and representations submitted we conclude an examination of trust reveals none of the circumstances that would cause grantor to be treated as the owner of any portion of trust under sec_673 sec_674 sec_676 or sec_677 as long as the committee remains in existence and serving because none of the members of committee have a power exercisable by himself to vest trust income or corpus in himself none shall be treated as the owner of trust under sec_678 we further conclude that an examination of trust reveals none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of grantor under sec_675 thus the circumstances attendant on the operation of trust will determine whether grantor will be treated as the owner of any portion of trust under sec_675 this is a question of fact the determination of which must be deferred until the federal_income_tax returns of the parties involved have been examined by the office with responsibility for such examination ruling sec_2 and sec_2501 provides that a tax is imposed for each calendar_year on the transfer of property by gift during such calendar_year by any individual resident or nonresident sec_2511 provides that the gift_tax applies whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_25_2511-2 of the gift_tax regulations provides that a gift is complete as to any property or part thereof or interest therein of which the donor has so parted with dominion and control as to leave in the donor no power to change its disposition whether for his own benefit or for the benefit of another but if upon a transfer of plr-105061-18 property whether in trust or otherwise the donor reserves any power over its disposition the gift may be wholly incomplete or may be partially complete and partially incomplete depending upon all the facts in the particular case accordingly in every case of a transfer of property subject_to a reserved power the terms of the power must be examined and its scope determined sec_25_2511-2 provides an example where the donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee and the donor retains a testamentary power to appoint the remainder among the donor’s descendants the regulation concludes that no portion of the transfer is a completed_gift however if the donor had not retained a testamentary_power_of_appointment but instead provided that the remainder should go to x or his heirs the entire transfer would be a completed_gift sec_25_2511-2 provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title in himself or herself a gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed_or_ascertainable_standard under sec_25_2511-2 a donor is considered as himself having a power if it is exercisable by the donor in conjunction with any person not having a substantial adverse_interest in the disposition of the transferred property or the income therefrom a trustee as such is not a person having an adverse_interest in the disposition of the trust property or its income sec_25_2511-2 provides that the relinquishment or termination of a power to change the beneficiaries of transferred property occurring otherwise than by death of the donor is regarded as the event which completes the gift and causes the gift_tax to apply sec_25_2511-2 provides that if a donor transfers property to himself as trustee or to himself and some other person not possessing a substantial adverse_interest as trustees and retains no beneficial_interest in the trust property and no power over it except fiduciary powers the exercise or nonexercise of which is limited by a fixed_or_ascertainable_standard to change the beneficiaries of the transferred property the donor has made a completed_gift and the entire value of the transferred property is subject_to the gift_tax sec_25_2511-2 does not define substantial adverse_interest sec_25_2514-3 provides in part that a taker in default of appointment under a power has an interest that is adverse to an exercise of the power sec_25_2514-3 plr-105061-18 also provides that a co-holder of a power is considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate in 308_us_39 the taxpayer created a_trust for the benefit of named beneficiaries and reserved the power_to_revoke the trust in whole or in part and to designate new beneficiaries other than himself six years later in the taxpayer relinquished the power_to_revoke the trust but retained the right to change the beneficiaries in the taxpayer relinquished the right to change the beneficiaries the court stated that the taxpayer’s gift is not complete for purposes of the gift_tax when the donor has reserved the power to determine those others who would ultimately receive the property accordingly the court held that the taxpayer’s gift was complete in when he relinquished his right to change the beneficiaries of the trust a grantor’s retention of a power to change the beneficial interests in a_trust causes the transfer to the trust to be incomplete for gift_tax purposes even though the power may be defeated by the actions of third parties 37_tc_897 see also 51_tc_352 in this case grantor retained the grantor’s consent power over the income and principal of trust under sec_25_2511-2 a donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse_interest in the disposition of the transferred property or the income therefrom the distribution committee members are not takers in default for purposes of sec_25_2514-3 they are merely co-holders of the power under sec_25_2514-3 a co-holder of a power is only considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate in this case the distribution committee ceases to exist upon the earlier of such time as there are fewer than two members serving or the grantor’s death accordingly the distribution committee members do not have interests adverse to grantor under sec_25_2514-3 and for purposes of sec_25_2511-2 therefore grantor is considered as possessing the power to distribute income and principal to any beneficiary because grantor retained the grantor’s consent power grantor also retained the grantor’s sole power over the principal of trust under sec_25_2511-2 a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed_or_ascertainable_standard in this case the grantor’s sole power gives grantor the power to change the interests of the beneficiaries even though grantor’s power is limited by an ascertainable_standard ie health education maintenance and support grantor’s power is not a fiduciary power accordingly the retention of grantor’s plr-105061-18 consent power and the grantor’s sole power over the income and principal causes the transfer of property to trust to be wholly incomplete for federal gift_tax purposes further grantor retained the grantor’s testamentary power to appoint the property to or for the benefit of any person or persons or entity or entities other than grantor’s estate grantor’s creditors or the creditors of grantor’s estate under sec_25_2514-3 the retention of a testamentary power to appoint the remainder of a_trust is considered a retention of dominion and control_over the remainder accordingly the retention of this power causes the transfer of property to trust to be incomplete with respect to the remainder of trust for federal tax purposes finally the distribution committee members possess the unanimous member power over income and principal this power is not a condition_precedent to grantor’s powers grantor’s powers over the income and principal of trust are presently exercisable and not subject_to a condition_precedent grantor retains dominion and control_over the income and principal of trust until the distribution committee members exercise their unanimous member power accordingly the unanimous member power does not cause the transfer of property to be complete for federal gift_tax purposes see 37_tc_897 51_tc_352 accordingly based on the facts submitted and the representations made we conclude that grantor’s contribution of property to trust is not a completed_gift subject_to federal gift_tax any distribution from trust to grantor is merely a return of grantor’s property therefore we conclude that any distribution_of_property from trust by the distribution committee to grantor will not be a completed_gift subject_to federal gift_tax by any member of the distribution committee further upon the death of grantor the fair_market_value of the property in trust is includible in grantor’s gross_estate for federal estate_tax purposes ruling sec_2514 provides that the exercise or release of a general_power_of_appointment created after date shall be deemed a transfer of property by the individual possessing such power sec_2514 provides that the term general_power_of_appointment means a power which is exercisable in favor of the individual possessing the power possessor the possessor’s estate the possessor’s creditors or the creditors of the possessor’s estate sec_25_2514-1 provides that a power_of_appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or plr-105061-18 classes other than the possessor or his creditors or the possessor’s estate or the creditors of the estate or expressly not exercisable in favor or the possessor or his creditors or the possessor’s estate or the creditors of his estate sec_2514 provides that in the case of a power_of_appointment created after date if the power is exercisable by the possessor only in conjunction with the creator of the power such power is not deemed a general_power_of_appointment sec_2514 provides that in the case of a power_of_appointment created after date if the power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject_to the power which is adverse to the exercise of the power in favor of the possessor such power shall not be deemed a general_power_of_appointment for purposes of sec_2514 a person who after the death of the possessor may be possessed of a power_of_appointment with respect to the property subject_to the possessor’s power which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the possessor’s power sec_25_2514-3 provides in part that a co-holder of a power_of_appointment has no adverse_interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power however a co-holder of a power is considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate thus for example if x y and z held a power jointly to appoint among a group of persons which includes themselves and if on the death of x the power will pass to y and z jointly then y and z are considered to have interests adverse to the exercise of the power in favor of x similarly if on y’s death the power will pass to z z is considered to have an interest adverse to the exercise of the power in favor of y the power held by the distribution committee members under the grantor’s consent power is a power that is exercisable only in conjunction with the creator grantor accordingly under sec_2514 the distribution committee members do not possess general powers of appointment by virtue of possessing this power further the power held by the distribution committee members under the unanimous member power is not a general_power_of_appointment for purposes of sec_2514 as in the example in sec_25_2514-3 the distribution committee members have substantial adverse interests in the property subject_to this power accordingly any distribution from trust to a beneficiary other than grantor pursuant to the exercise of these powers the grantor’s consent power and the unanimous member power are not gifts plr-105061-18 by the distribution committee members instead such distributions are gifts by grantor based on the facts submitted and the representations made we conclude that any distribution_of_property by the distribution committee to any beneficiary of trust other than grantor will not be a completed_gift subject_to federal gift_tax by any member of the distribution committee further we conclude that any distribution_of_property from trust to a beneficiary other than to grantor will be a completed_gift by grantor except as specifically ruled herein we express no opinion on the federal tax consequences of the transaction under the cited provisions or under any other provisions of the code specifically we express no opinion on the trust provisions permitting trustee to distribute income or principal to trustees of other trusts decanting or any other trust provisions not referenced in this private_letter_ruling this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely melissa c liquerman melissa c liquerman chief branch office of associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes copy of this letter


internal_revenue_service department of the treasury index number u i l no washington dc person to contact telephone number refer reply to cc dom p si plr-100193-00 date date number release date legend company state shareholders a this letter responds to a letter dated date requesting a ruling on behalf of company under sec_1362 of the internal_revenue_code the information submitted discloses that company was incorporated on a in state company has four shareholders shareholders it is represented that company has intended to be an s_corporation since its incorporation believing itself to be an s_corporation company has operated accordingly since a after the end of its taxable_year beginning on a however company discovered that its s election had not been timely filed company requests a ruling that its sec_1362 election will be treated as timely made for its taxable_year that begins on a sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 explains when an s election will be effective generally if an s election is made within the first two and one half months of a corporation's taxable_year plr-100193-00 then that corporation will be treated as an s_corporation for the year in which the election is made sec_1362 provides that if an s election is made after the first two and one half months of a corporation’s taxable_year then that corporation will not be treated as an s_corporation until the taxable_year following the year in which the s election is made sec_1362 provides that if no sec_1362 election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply applying the relevant law to the facts submitted and representations made we rule that company's sec_1362 election will be treated as timely made for its taxable_year that begins on a however this ruling is contingent on company filing form_2553 election by a small_business_corporation with an effective date of a with the appropriate service_center within days from the date of this ruling a copy of this letter should be attached to the form_2553 except as specifically set forth above we express no opinion concerning the federal tax consequences of the foregoing facts specifically we express no opinion on whether company otherwise qualifies as an s_corporation this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely yours william p o’shea chief branch office of the assistant chief_counsel passthroughs and special industries enclosure copy for sec_6110 purposes


t c memo united_states tax_court manaharlal c parekh and elizabeth parekh petitioners v commissioner of internal revenue respondent docket no filed date michael d cropper for petitioners michael c prindible for respondent memorandum findings_of_fact and opinion vasquez judge respondent determined deficiencies in petitioners' and federal income taxes in the amounts of dollar_figure and dollar_figure respectively all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure the issues for decision are whether petitioners are entitled to a deduction under sec_162 or under sec_165 e for a dollar_figure payment in connection with a guarantor agreement and whether petitioners may include the dollar_figure payment in computing net operating losses nol's from the bankruptcy_estate of petitioner manaharlal c parekh findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners husband and wife resided in odessa texas at the time they filed the petition in this case petitioners filed joint federal_income_tax returns for the and taxable years manaharlal c parekh petitioner is a thoracic and peripheral vascular surgeon who practices in the midland odessa area of texas at trial petitioners raised for the first time the deductibility of the dollar_figure payment under sec_165 as a theft_loss we will not as a general_rule consider an issue raised for the first time at trial since it has not been properly pleaded see 64_tc_61 when issues not raised by the pleadings are tried by implied consent of the parties however the issues shall be treated as if they had been raised in the pleadings rule b the parties satisfied rule b when they introduced the issue at trial and acquiesced in the introduction of evidence on that issue without objection 103_tc_525 affd 100_f3d_778 10th cir see also 691_f2d_449 10th cir during the years in issue petitioner's close friend ignacio cisneros cisneros was involved in insulation manufacturing in date cisneros introduced petitioner to dwight chester wheeler wheeler cisneros wheeler and petitioner were interested in constructing an insulation manufacturing plant the plant hoping to generate revenue for the construction of the plant petitioner cisneros and wheeler met on several occasions to discuss investment opportunities on date the three formed a partnership called permian energy co the partnership to invest in producing oil_and_gas_properties over a period of several months wheeler showed petitioner various oil well sec_2 the wells which were producing very little oil and encouraged petitioner to put money into the partnership so that the wells could be worked over wheeler advised petitioner that oil_and_gas production would increase if the wells were worked over by perforating different zones in the geological formation in order for the partnership to work over the wells petitioner contributed additional funds to the company the partnership's checks required at least two signatures to draw on its account petitioner cisneros and wheeler had the authority to sign the checks during initial operations of the it is not clear from the record but it appears that wheeler initially owned the oil leases and he contributed them to the partnership partnership wheeler advised petitioner that he needed blank checks drawn on the partnership account to pay for oil field services petitioner allowed wheeler access to the requested checks from april to about date the partnership had spent dollar_figure to dollar_figure in working over four or five oil wells and production had not increased wheeler approached petitioner several times about acquiring a package of leases on good- producing wells from amoco oil co amoco on date the partnership was incorporated and became permian energy co pec petitioner was the sole shareholder of pec the members of pec's board_of directors were petitioners and cisneros on date the board_of directors of pec authorized and directed petitioner and cisneros to borrow up to dollar_figure on behalf of pec for the purpose of purchasing certain oil_and_gas_properties from amoco on date pec borrowed dollar_figure from interfirst bank odessa n a the bank to purchase those oil_and_gas_properties from amoco pec and the bank executed a promissory note the note with an original maturity_date of date petitioner guaranteed the note after several extensions of the maturity interfirst bank odessa n a subsequently became first republic bank odessa n a then became ncnb texas national bank of odessa texas and now is known as nationsbank date the bank and pec agreed to a final maturity_date sometime in from to there was a substantial decrease in oil production from the wells that pec had purchased additionally the posted crude_oil prices dropped from dollar_figure per barrel in date to dollar_figure per barrel in date pec reported gross_sales and net losses for tax purposes as follows year ending gross oil june gas income net_loss dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number theft_loss on date petitioner and cisneros suspected that wheeler had misappropriated about dollar_figure of pec's funds which was supposed to be used to pay a commission in addition petitioner believed that wheeler cashed the blank checks petitioner gave him and he misappropriated these funds for his personal_use consequently on date petitioner changed the locks to pec's office and informed wheeler that he was not to enter the office in date petitioner and cisneros met with representatives from the texas rangers--the law enforcement division for the state of texas petitioner and cisneros informed the texas rangers of their suspicion that wheeler had stolen money from pec by the end of petitioner believed he knew how much wheeler had stolen from either him or pec wheeler died in petitioners did not claim a theft_loss deduction on their or income_tax return on or about date petitioners timely filed an amended tax_return and a claim_for_refund for the taxable_year petitioners based their claim_for_refund upon a theft_loss deduction in the amount of dollar_figure which they allege wheeler stole from petitioner on date the internal_revenue_service denied petitioners' claim_for_refund for the taxable_year default on bank loan by pec in pec was unable to make payments due under the note in date the bank turned to petitioner to perform on his guarantor agreement on date the bank obtained a default judgment against petitioner the default judgment in the amount of dollar_figure with respect to petitioner's guaranty on the note on date the bank obtained from the texas state district_court a temporary restraining order to enjoin petitioner from conveying encumbering or disposing of any of his assets on date petitioner filed for protection under chapter of the bankruptcy code in the u s bankruptcy court for the western district of texas el paso division the bankruptcy court on date the bank filed an original verified complaint and application_for temporary restraining order and preliminary injunction combined with complaint for declaratory_judgment the complaint in petitioner's bankruptcy case the complaint sought to offset a pension fund deposit account and two commercial checking accounts maintained by petitioner at the bank against the amount owed by pec to the bank on or about date the bank filed an amended proof_of_claim in petitioner's bankruptcy case in the amount of dollar_figure in response to the complaint the bankruptcy court entered an order the order in date which permitted the bank to exercise setoff rights on dollar_figure of funds from petitioner's bank accounts and required petitioner to pay approximately dollar_figure to the bank from petitioner's property acquired after filing the bankruptcy petition for a total of dollar_figure on date petitioner and his bankruptcy_estate through bank offsets and direct payments paid a total of dollar_figure to the bank in satisfaction of the bank's amended proof_of_claim on petitioners' joint income_tax return petitioners claimed deductions for nol's from the bankruptcy_estate and for expenses to protect petitioner's business reputation in the amounts of dollar_figure and dollar_figure respectively for the taxable_year petitioners claimed an nol_carryover from in the amount of dollar_figure although petitioners prepared tax returns for the bankruptcy_estate for the and taxable years they were not filed as of the time petitioners filed the petition in this case opinion the first issue is whether petitioner's dollar_figure payment as a guarantor of the note is deductible as an ordinary_loss under sec_162 or under sec_165 petitioner contends that the amount in question is deductible under sec_162 or alternatively under sec_165 petitioner alleges that wheeler stole from pec by misappropriating funds from pec petitioner argues that those losses resulted in pec's inability to make payments due under the note and consequently the bank turned to petitioner to perform on the note petitioner also argues that because pec did not financially exist separately from petitioner he is entitled to a theft_loss deduction under sec_165 of the amount_paid to the bank in alternatively petitioner contends that the payments were made to the bank to protect his business reputation and therefore are deductible under sec_162 respondent contends that the amount_paid on the guaranty is a nonbusiness_bad_debt which is deductible only as a short-term_capital_loss under sec_166 and sec_1_166-9 income_tax regs we agree with respondent guarantor payments sec_166 allows a deduction for the loss sustained on account of a bad_debt a deduction is allowed to the extent that the debt becomes worthless during the year sec_166 sec_1_166-9 income_tax regs applies to a taxpayer who enters into a transaction for profit but not in the course of his trade_or_business to act as a guarantor endorser or indemnitor this section of the regulations provides that a payment of principal or interest made by the taxpayer in discharge of part or all of the taxpayer's obligation as a guarantor endorser or indemnitor is treated as a worthless nonbusiness_debt sec_1_166-9 income_tax regs further provides that neither sec_163 nor sec_165 will apply with respect to such a payment therefore if the payment falls under both sec_165 and sec_166 then it can be deducted only as a bad_debt under sec_166 106_tc_312 affd without published opinion 121_f3d_723 11th cir see 352_us_82 292_us_182 59_tc_319 affd 523_f2d_1363 9th cir petitioner guaranteed the promissory note upon pec's failure to perform on the note petitioner was obligated to make payments to the bank under the guarantor agreement with or without a right of subrogation a guarantor's loss generally will be in the nature of a bad_debt_loss and will fall under sec_166 99_tc_482 affd without published opinion 33_f3d_62 10th cir 52_tc_140 affd per curiam 424_f2d_1368 9th cir therefore we conclude that the payment in the amount of dollar_figure to discharge petitioner's existing obligation under the guarantor agreement is deductible under sec_166 as a nonbusiness_bad_debt because sec_1_166-9 income_tax regs provides that the guarantor payments are a nonbusiness_debt we need not determine whether petitioner sustained a theft_loss thus if the payment is not deductible under another section petitioners may deduct the dollar_figure only to the extent of net capital_gains plus dollar_figure and may carry forward the remaining capital_loss to succeeding taxable years sec_1211 and sec_1212 we note that respondent has allowed a dollar_figure short- term capital_loss deduction for each of the years in issue we also note that petitioner makes no contention that the dollar_figure is deductible as a business_bad_debt we note that if there was a loss as a result of misappropriations by wheeler it occurred before the years at issue under sec_165 a theft_loss is deductible in the taxable_year in which the taxpayer discovers the loss additionally even if there was a loss in the years at issue it was sustained by pec and not by petitioners the record shows continued business reputation petitioner argues that he may deduct the bankruptcy settlement payments under sec_162 as expenses to protect his business reputation petitioner bases the deductibility of the payments upon the adverse business consequences that would have resulted to his medical practice from a failure to pay the default judgment and bankruptcy order generally a taxpayer may deduct ordinary and necessary expenses paid_or_incurred in carrying on his trade_or_business sec_162 we have however concluded that the dollar_figure payment is a nonbusiness_debt if a guarantor's payment is found to give rise to a debt then the guarantor cannot deduct the payment as a business_expense under sec_162 105_tc_126 see horne v commissioner supra pincite in that event the guarantor can deduct the payment only when and in the amount permitted under sec_166 see horne v commissioner supra pincite we have determined that the guarantor payment is a nonbusiness_debt and therefore the payment cannot be deductible under sec_162 nol continued that petitioner maintained pec as an entity distinct from himself where the taxpayer has availed himself of the corporate form this court generally will not disregard the existence of the corporation in order to reduce the taxpayer's tax_liability 51_tc_746 we must next determine whether the dollar_figure payment is included in the nol's available to petitioners from the bankruptcy_estate for the taxable_year sec_172 defines nol as the excess of deductions over the taxpayer's gross_income subject_to modifications of sec_172 in determining whether there is an excess of deductions over gross_income capital losses are allowed only to the extent of capital_gains sec_172 net capital losses are excluded from the nol computation by sec_172 we have concluded that petitioner's dollar_figure payment is deductible only as a nonbusiness_bad_debt under sec_166 a nonbusiness_bad_debt is deductible only as a short-term_capital_loss therefore we hold that petitioners are not entitled to include the payment in computing nol's from petitioner's bankruptcy_estate to reflect the foregoing decision will be entered for respondent