t cc no united_states tax_court microsoft corporation petitioner v commissioner of internal revenue respondent docket no filed date during and petitioner engaged its wholly owned subsidiary a foreign_sales_corporation to act as its agent for the international sales of standardized mass-marketed computer_software products and computer_software masters the standardized software products were copyrighted articles sold without a right to reproduce abroad the software masters were licensed to related foreign subsidiaries and unrelated foreign equipment manufacturers with a right to reproduce abroad in the notices of deficiency respondent allowed the deductions for the foreign_sales_corporation commissions attributable to the standardized software products but denied them with respect to the export of the software masters the issue is whether the software masters -- - constitute export_property within the meaning of sec_927 a i r c and sec_1_927_a_-1t temporary income_tax regs fed reg date the temporary_regulation held the temporary_regulation is a reasonable and valid interpretation of sec_927 b i r c held further computer_software masters do not constitute sec_927 i r c export_property james m o’brien michael p boyle john m peterson jr thomas v m linguanti andrew j gottlieb neal j block scott h frewing robert b mitchell michael j bernard and william h burkhart for petitioner david p fuller john m altman ronald m rosen kimberley j peterson michelle d korbas and kevin g croke for respondent jacobs judge pursuant to two notices of deficiency addressed to petitioner respondent determined federal_income_tax deficiencies and an overpayment as follows tax_year ended june deficiency overpayment dollar_figure ---- big_number --- big_number --- --- dollar_figure big_number --- the deficiencies determined for are attributable to respondent’s adjustments to general_business_credit carrybacks from - - and to and to foreign_tax_credit carrybacks from to and these adjustments are computational arising from income adjustments for and introduction petitioner develops produces and markets computer_software during and petitioner engaged its wholly owned subsidiary microsoft fsc corp ms-fsc to act as its agent for the international sales of standardized mass-marketed computer products and computer_software masters ’ these products were sold licensed to petitioner’s controlled_foreign_corporations cfc’s and unrelated foreign original equipment manufacturers foreign oem’s pursuant to the foreign_sales_corporation provisions sec_921 through a domestic_corporation may receive favorable tax treatment on a portion of its profits from international sales of its u s -made products by selling leasing such products through a foreign corporate subsidiary the foreign_sales_corporation specifically that portion of the foreign sales corporation’s income known as exempt_foreign_trade_income is not subject_to u s taxation in the hands of the foreign_sales_corporation the_domestic_corporation may deduct the commission paid to the foreign_sales_corporation based upon the amount the foreign_sales_corporation reports as foreign trade gross_receipts using certain administrative pricing rules and the_domestic_corporation can exclude dividend distributions from its foreign_subsidiary eg the foreign_sales_corporation that are attributable to the foreign sales corporation’s exempt_foreign_trade_income q4e- pursuant to the licensing agreements with the cfc’s petitioner earned a royalty based upon a percentage of the cfc’s revenues from the sale of the licensed software products pursuant to the licensing agreements with the foreign oem’s petitioner earned a royalty equal to the greater of the oem’s computer systems sales or copies of the computer_software products distributed ms-fsc reported the royalties as foreign_trading_gross_receipts ftgr’s petitioner paid ms-fsc a commission based upon the amount ms-fsc reported as ftgr’s and deducted the foreign_sales_corporation fsc commission using the applicable administrative pricing rules it is the aforementioned royalties and fsc commissions that are at issue namely royalties--foreign oem’s dollar_figure big_number dollar_figure big_number fsc commissions per return big_number big_number royalties----cfc’s big_number big_number fsc commissions per return big_number big_number additional irish royalties big_number big_number additional fsc commissions per petition big_number big_number respondent determined that the disputed royalties were nonqualifying ftgr’s as a result respondent disallowed fsc commission deductions of dollar_figure for ie dollar_figure dollar_figure and dollar_figure for e dollar_figure - - dollar_figure which petitioner claimed in connection with its computer_software masters exported for reproduction and distribution abroad petitioner also claimed fsc commission deductions of dollar_figure for and dollar_figure for with respect to its export sales of standardized software products respondent has allowed these deductions the dispositive issue to be resolved is whether the royalties attributable to the licensees’ reproduction and distribution of petitioner’s computer_software masters outside the united_states constitute ftgr’s within the purview of sec_924 resolution of this issue hinges upon whether the licensed computer_software masters constitute export_property within the meaning of sec_927 and the temporary regulations thereunder unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are found accordingly the stipulations of facts and the attached exhibits are incorporated herein by this reference a background petitioner a washington corporation maintained its principal_place_of_business in redmond washington at the time the petition -- - was filed it was the common parent of an affiliated_group_of_corporations which filed consolidated forms u s_corporation income_tax return for and during the years in issue petitioner conducted its business through several operating groups systems software applications software systems peripherals and accessories group oem sales u s sales and marketing international operations and press approximately three-quarters of petitioner’s worldwide employees were based in redmond where petitioner developed its products b ms-fsc ms-fsc was organized as a virgin islands corporation on date on date petitioner and ms-fsc entered into a commission and expense agreement which remained in effect during the years in issue at all relevant times ms-fsc elected to be taxed as a foreign_sales_corporation and was so qualified ms-fsc determined itss commission income using sec_925 administrative pricing rules c petitioner’s products petitioner’s first products were programming languages and tools that permitted software developers to create computer_software thereafter petitioner’s product line was expanded to include operating systems in petitioner released its first operating system microsoft disk operating system or ms-dos for international business machine’s ibm’s first microcomputer ms-dos was the operating system used on a majority of ibm’s personal computers and ibm-compatible personal computers petitioner ms-dos ibm pc-dos or ibm-dos digital research dr- dos and other companies marketed a disk operating system dos under various names dos was a text or character-based system it required computer users to input words or characters to give the computer commands since operating systems software has continually evolved to permit computer users to accomplish increasingly diverse and complex tasks on computers in addition to ms-dos petitioner marketed other proprietary operating systems during the years at issue such as microsoft windows microsoft lan manager and xenix at that time ms-- dos accounted for the largest number of microsoft operating system units distributed microsoft windows was second in the early 1980's petitioner also began to develop and market application software products in order to increase the appeal of the microcomputer petitioner’s applications included word processing eg microsoft word spreadsheet computations eg microsoft excel graphics eg microsoft powerpoint and video games eg microsoft flight simulator in and petitioner offered a wide line of application software products --- - petitioner created its software products at its redmond facilities it took to several hundred persons to develop a computer_software product e microsoft windows or microsoft excel petitioner’s product development which could take up to years involved three phases product planning during which a functional specification and final schedule were prepared months product development during which the source code was completed and was further revised in the next phase months and product stabilization during which a gold master was produced and the software product was released for duplication months d production of masters for export from an american-made gold master petitioner’s product release services group prs in redmond produced master copies of the software and related documentation for distribution to petitioner’s canyon park facility the foreign oem’s and the cfc’s these masters contained object code for computer programs and related data files petitioner’s prs duplicated the masters on various media depending upon the size of the particular software product and the distribution channel petitioner’s products used magnetic tape for masters provided to the foreign oebm’s specifically during the years in issue prs provided masters to the foreign oebem’s on 25-inch magnetic tapes --- - 25-inch diskettes and 5-inch diskettes the software masters remained petitioner’s property and were unavailable for distribution to third parties after petitioner provided the foreign oem or cfc with a software master the licensee stored the information on a network computer and archived the master for security or production purposes upon transfer to the network the licensee’s duplication equipment accessed the digital information to initiate duplication runs br petitioner’s export transactions petitioner distributed its computer_software products worldwide in connection with its sales abroad petitioner used two types of channels the foreign oem channel and the international retail channel the products distributed through these channels were duplicated both in the united_states and abroad petitioner’s international revenues from both the foreign oem and retail channels constituted percent of petitioner’s total revenues for and percent for ff foreign ofm channel petitioner’s foreign oem channel consisted of computer manufacturers that installed petitioner’s software directly into the hard drive of a computer and or bundled software-encoded media along with the computer the foreign oebm’s distributed petitioner’s computer_software as a component of their own computer systems - in and approximately foreign oem’s distributed petitioner’s software products operating systems constituted the bulk of these products during these years approximately foreign oem’s paid royalties to petitioner pursuant to the oem agreements the top products licensed to the foreign oem’s ranked in terms of royalties petitioner accrued were as follows product units revenue units revenue ms-dos big_number dollar_figure big_number dollar_figure gw-basic interpreter big_number big_number big_number big_number windows big_number big_number big_number big_number window sec_386 big_number big_number big_number big_number os big_number big_number big_number big_number shell dos big_number big_number big_number ms-works big_number big_number big_number big_number lan manager big_number big_number big_number big_number networks big_number big_number big_number big_number basic interpreter big_number big_number big_number big_number these products represented approximately percent of petitioner’s foreign oem licensing revenues for and approximately percent for during and petitioner also licensed applications and other software products to the foreign oem’s g standard ofm license agreement petitioner’s oem business personnel and legal staff drafted a standard exemplar oem license agreement the standard oem agreement as the basis for negotiating licenses with the foreign oebm’s the standard oem agreement was the starting point from which negotiations ensued whether a foreign oem and petitioner entered into a license agreement or a distribution agreement depended upon several factors such as the foreign oem’s projected volume of computer sales the size of the market for a particular software product and petitioner’s confidence in the foreign oem’s trustworthiness and recordkeeping pertinent provisions of the standard oem agreement include the following provisions license grant a ms microsoft grants to company licensee the following nonexclusive worldwide license rights to adapt the product as necessary to enable it to execute on company’s customer system s to reproduce and manufacture the product in object code form and to distribute directly or indirectly and license the product in object code form to end users under the terms of company’s end user license agreement all rights not expressly granted including without limitation translation rights are reserved by ms copyright notices trademarks a company will cause to appear on the container and labels of each copy of product the copyright and patent notices for the product that appear on the applicable release of the product as provided to company pursuant to sec_2 hereof b company shall market the product only under the product name s for such product as specified and company agrees to use the appropriate trademark symbol and clearly indicate ms’ ownership of its trademark s whenever the product name is first mentioned in any advertisement brochure or in any other manner in connection with the product company’s name and or trademarks shall not be displayed in relation to the product name in a manner which suggests that company’s name and or trademarks are part of the product name company agrees to maintain the high level of quality accorded products associated with and marketed by ms under ms’ trademarks company shall not use or display any ms logo in its materials or packaging without ms’ prior written permission company shall not use or imitate the trade dress of ms products company’s name and or trademarks shall be displayed on the packaging and disk labels for the product at least as prominently as the name microsoft upon request company shall submit the product in proposed finished goods form including software and documentation to ms for approval prior to distribution which approval shall not be unreasonably withheld company shall upon regquest provide ms samples of all company literature which uses product name s company shall provide ms with five copies of the product in finished goods form nondisclosure agreement company expressly undertakes to retain in confidence and to reguire its distributors to retain in confidence all information and know how transmitted to company by ms that ms has identified as being proprietary and or confidential or that by the nature of the circumstances surrounding the disclosure ought in good_faith to be treated as proprietary and or confidential and will make no use of such information and know-how except under the terms and during the existence of this agreement however company shall have no obligation to maintain the confidentiality of information that it received rightfully from another party prior to its receipt from ms ms has disclosed to a third party without any obligation to maintain such information in confidence or is independently developed by company further company may disclose confidential information as required by governmental or judicial order provided company gives ms prompt notice of such order and complies with any protective_order or equivalent imposed on such disclosure company shall treat all product adaptation materials including source code as confidential information and shall not disclose disseminate or distribute such materials to any third party without ms’ prior written permission company shall treat the terms and conditions of this agreement as confidential however company may disclose such information in confidence to its immediate legal and financial consultants as required in the ordinary course of company’s business company’s obligation under this section shall extend to the earlier of such time as the information protected hereby is in the public domain through no fault of company or ten years following termination or expiration of this agreement controlling law no franchise a this agreement shall be construed and controlled by the laws of the state of washington and company consents to jurisdiction and venue in the state and federal courts sitting in the state of washington xk general f the section headings used in this agreement and the attached exhibits are intended for convenience only and shall not be deemed to supersede or modify any provisions the oem agreements granted the licensee the right to modify reproduce and distribute the licensed software and derivative work on or with the foreign oem’s hardware systems specified in each agreement the royalties at issue were paid as consideration pursuant to these agreements which computed the royalty on a per copy or per system basis the foreign oem’s paid a royalty for each copy of the copyrighted work duplicated and distributed in the market or for each computer system manufactured and sold by the foreign oem's the oem agreements required the foreign oem’s to make minimum commitment payments quarterly to the extent earned royalties exceeded the cumulative minimum commitment payments the foreign oem’s were required to pay petitioner for actual earned royalties to the extent cumulative minimum commitment payments exceeded actual earned royalties the excess was considered prepaid royalties and was recoupable against future earned royalties during the term of the license agreement the standard oem agreement was for a 2-year term the foreign oem’s generally extended their relationship with petitioner by entering into subsequent agreements licensing later releases and versions of the same software the proprietary information petitioner transferred to the foreign oem’s pursuant to the standard ofm agreement was maintained as a trade secret the parties have stipulated that this proprietary information included algorithms processes formulas and designs the foreign oem’s could also license petitioner’s source code for specific products pursuant to a separate royalty--bearing license arrangement source code license a source code license authorized the foreign oem to use the source code solely for - - internal use in furtherance of its license to adapt reproduce and distribute the computer_software in object code form pertinent provisions of the source code license are as follows license grant for source code a ms grants to company a nonexclusive personal nontransferable nonassignable license during the term of the agreement to use and modify the source codes of the products source code b the license granted hereunder shall extend to the source code for any new releases to each product as are supplied by ms and accepted by company c company hereby conveys to ms all right title and interest to any modifications made to the source code by company ms grants to company non-exclusive marketing and distribution rights to the object code version of any modifications made to the source code by company d notwithstanding anything to the contrary contained herein company shall not reproduce duplicate copy or otherwise disclose distribute or disseminate source code code or listing in any media except for company’s own internal use by company’s- full-time employees on a need-to-know basis on company premises xk the foreign oem’s paid royalties for the source code in addition to other royalty payments in some instances petitioner provided a foreign oem with an oem adaptation kit oak which contained a copy of the product’s object code sample adaptation code and related documentation an oak assisted foreign oem’s to adapt operating systems to personal computers whether a foreign ofm needed the adaptation code depended on its particular computers -- - h international retail channel in and petitioner exported shrink-wrapped software’ products made in the united_states to its cfc’s for distribution to end users outside the united_states in addition petitioner licensed its cfc’s the rights to duplicate and distribute shrink- wrapped software packages outside the united_states pursuant to cfc or product localization agreements in most instances the cfc’s localized petitioner’s software and then manufactured copies of the localized software for distribution as shrink-wrapped products the cfc’s in ireland microsoft ireland japan microsoft japan korea microsoft korea and taiwan microsoft taiwan reproduced packaged and distributed retail products for the international retail channel as well as white box products for the international oem channel a retail product consisted of an individual copy of the software marketed in a decorative retail box shrink-wrapped software containing software-loaded storage media user manuals and other documentation a white box product consisted of software-loaded media and product documentation packaged in a plain white box intended to deter separate retail sales by a foreign oem microsoft ireland manufactured both retail shrink-wrap packaging consisted of packing the software-loaded diskettes with manuals and other printed materials in shrink-wrapped boxes bearing graphics product information trademark registrations trade names and other trade dress the warehousing operation consisted of storing and shipping the shrink-wrapped software packages and white box products from masters petitioner supplied microsoft japan microsoft taiwan and microsoft korea used subcontractors to duplicate and distribute both retail and white box products the cfc agreements with microsoft taiwan microsoft korea and microsoft japan imposed a mandatory trademark branding requirement on the cfc’s the cfc agreements with microsoft ireland included an express trademark license petitioner generally sent the master diskettes to the cfc’s containing object code for the licensed retail products similar to the orm agreements the cfc agreements imposed obligations on the cfc’s to maintain in confidence all trade secret information petitioner provided pursuant to the cfc agreements petitioner ultimately received royalties from the cfc’s ms-fsc reported the royalties on its returns as ftgrs from transactions in gualifying export_property the royalties in dispute are those received from microsoft japan microsoft korea microsoft ireland and microsoft taiwan in and paid pursuant to the cfc agreements during the years in issue microsoft ireland accounted for approximately percent of petitioner’s royalty accruals from the cfc’s petitioner did not allocate or apportion the royalty stream from the cfc’s and oem’s among intellectual_property rights respondent determined that the royalties petitioner accrued from its export licensing transactions were not ftgr’s on the basis that the - - royalty income did not arise from transactions in export_property e the income arose from disqualified intangibles opinion a the statutes in congress enacted the domestic_international_sales_corporation disc provisions sec_991 through see revenue act of publaw_92_178 85_stat_497 to provide an export tax incentive to u s businesses and to improve the country’s balance of payments see s rept pincite 1972_1_cb_559 the disc provisions attempted to equalize tax treatment between u s companies that sold goods in foreign markets regardless of whether the goods were made in the united_states these provisions allowed domestic corporations to defer taxes on a substantial portion of profits from export sales similar to the tax benefits available to corporations manufacturing abroad through foreign subsidiaries see h rept pincite 1972_1_cb_498 s rept supra pincite c b pincite in congress supplemented the disc provisions with the foreign_sales_corporation fsc provisions sec_921 through see deficit_reduction_act_of_1984 publaw_98_369 98_stat_494 in order to comply with the general agreement on tariffs and trade see s prt vol i pincite comm print under the fsc provisions a taxpayer may permanently exclude from federal_income_tax a portion of its profits from qualifying export sales both the disc and the fsc provisions reallocate a portion of a u s company’s profits attributable to its export of american-made products the proper amount of the reallocation for and is in controversy only activities that generate ftgr’s qualify for fsc benefits ftgr’s are the gross_receipts of an fsc that are from the sale exchange or other_disposition of export_property from the lease or rental of export_property for use by the lessee outside the united_states for services which are related and subsidiary to-- on date the world trade organization wto appellate body upheld an date wto panel ruling that the u s foreign_sales_corporation fsc tax regime is essentially an export subsidy in contravention of wto rules the panel recommended that the united_states comply with the wto ruling by date or face the prospect of ehuropean union retaliation in date the united_states proposed to the european union an fsc replacement system with tax benefits generally applying to foreign_income from all foreign sales rentals and leases regardless of whether goods are manufactured in the united_states or abroad the european union rejected this proposal maintaining that the system would continue to make tax benefits contingent upon exports as of the release date of this opinion h_r 106th cong 2d sess the fsc repeal and extraterritorial_income_exclusion act of is under consideration in order to bring the u s export tax regime into conformity with the wto ruling - - a any sale exchange or other_disposition of export_property by such corporation or b any lease or rental of export_property described in paragraph by such corporation for engineering or architectural services for construction projects located or proposed for location outside the united_states or for the performance of managerial_services for an unrelated fsc or disc in furtherance of the production of foreign_trading_gross_receipts described in paragraph or sec_924 the fsc and disc provisions define export_property as property manufactured produced grown or extracted in the united_states sec_927 a c a however export_property does not include patents inventions models designs formulas or processes whether or not patented copyrights other than films tapes records or similar reproductions for commercial or home use good will trademarks trade brands franchises or other like property sec_927 a b c b these sections expressly exclude intangible_property from the definition of export_property the parenthetical phrase other than films tapes records or similar reproductions for commercial or home use the parenthetical ‘ the parties have stipulated that for purposes of this case petitioner’s software development in the united_states satisfied the manufacture or production requirement of sec_927 a a - limits the unfavorable treatment with regard to copyrights b the regulations sec_1_993-3 income_tax regs t d 1977_2_cb_266 was issued on date excluding copyrights in books from export_property treatment sec_1_993-3 income_tax regs provides intangible_property export_property does not include any patent invention model design formula or process whether or not patented or any copyright other than films tapes records or similar reproductions for commercial or home use goodwill trademark tradebrand franchise or other like property although a copyright such as a copyright on a book does not constitute export_property a the taxpayer_relief_act_of_1997 publaw_105_34 sec 111_stat_788 amended sec_927 asa result copyrights of computer_software are explicitly referred to as not being excluded_property 1ie such copyrights qualify as export_property the amendment applies to gross_receipts from computer_software licenses attributable to periods after in tax years ending after date the conference_report accompanying the taxpayer_relief_act_of_1997 states that no inference is intended as to the qualification of computer_software licensed for reproduction abroad as export_property under the pre-1997 law see h conf rept pincite 1997_4_cb_1457 in reaching our conclusions we have adhered to this pronouncement on date days before sec_1_993-3 income_tax regs was issued the acting commissioner of the internal_revenue_service sent a memorandum to the assistant secretary_of_the_treasury recommending approval of sec_1 f income_tax regs and attached a technical memorandum in support thereof the technical memorandum recognized that the parenthetical described a limited category of copyright_rights and sound_recording copyrights fell within the limited category of copyrights saved by the parenthetical -- - copyrighted_article such as a book if not accompanied by a right to reproduce it is export_property if the requirements of this section are otherwise satisfied however a license of a master recording tape for reproduction outside the united_states is not disqualified under this subparagraph from being export_property sec_1_993-3 income_tax regs does not explicitly refer to computer_software consequently the commissioner’s position with respect to whether computer_software qualifies as export_property for disc purposes was later expressed through the following pronouncements gen couns mem gcm big_number date concluded that mass--marketed software without reproduction rights may qualify as export_property under the disc rules as being akin to a copyrighted book tech adv mem tam date concluded that standardized mass- marketed computer_software without reproduction rights is sec_993 export_property and priv ltr rul plr date concluded that exported computer_software updates that were not copyrighted would qualify for disc benefits because the property was sold without reproduction rights we recognize that gcm’s tam’s and plr’s do not have the force of law and are not binding on us we mention these pronouncements merely to show the manner in which the commissioner interpreted and or applied the regulations - - on date the secretary promulgated sec_1 a - 1t temporary income_tax regs fed reg date the temporary_regulation effective for taxable years beginning after date the preamble to the temporary_regulation states in relevant part sec_1_927_a_-1t provides definitions of export_property for purposes of the fsc rules these definitions parallel in all important respects the definitions of export_property of a disc at dollar_figure3-3 these regulations at sec_1_927_a_-1t provide that export_property will include certain standardized computer_software on media that are mass-marketed without the right to reproduce for external use emphasis added fed reg the temporary_regulation provides intangible_property export_property does not include any patent invention model design formula or process whether or not patented or any copyright other than films tapes records or similar reproductions for commercial or home use goodwill trademark tradebrand franchise or other like property although a copyright such as copyright on a book or computer_software does not constitute export_property a copyrighted_article such as a book or standardized mass marketed computer_software if not accompanied by a right to reproduce for external use is export_property if the requirements of this section are otherwise satisfied computer_software referred to in the preceding sentence may be on any medium including but not limited to magnetic tape punched cards disks semi- conductor chips and circuit boards a license of a master recording tape for reproduction outside the united_states is not disqualified -- - under this paragraph from being export_property the emphasized portions reflect additions or changes from the language of sec_1_993-3 income_tax regs following the promulgation of the temporary_regulation the commissioner issued the following plr date concluded that even though the software therein was not subject_to a copyright the license agreement restricted its use and reproduction qualifying it as export_property plr date concluded that a master computer disk provided to distributors accompanied by a right to reproduce is not export_property also tapes in the parenthetical refers to audio or video tapes used in the entertainment industry and does not apply to magnetic tapes used in the computer_software industry and tam date concluded that computer_software conveyed through a licensing agreement that gives the licensee the right to reproduce the software is excluded from the term ‘export property’ also the technical_advice_memorandum reflected that the temporary_regulation limited the reproduction exclusion of sec_927 a b to reproductions used solely in the entertainment industry stating in relevant part the parenthetical exception in sec_927 a b of the code and sec_1 a - 1t of the regulations which is identical to and based on the parenthetical exception in sec_993 b should also be interpreted to include only audio or video tapes used in the entertainment industry and not magnetic computer_software tapes c industry position before enacting the fsc regime the senate_finance_committee received written submissions and held hearings on date see hearings on s before the senate comm on finance 98th cong 2d sess part of representatives from the software industry testified that the disc provisions were unclear as to the treatment of exported computer_software copyrights in this regard gerald k howard vice president for taxes sperry corp representing several computer business and electronics associations stated we ask that a disc rule that has caused us- some difficulty in the past be modified or clarified namely that the definition of gualified export_property be revised to include software we believe that this will assist in eliminating the uncertainty that exists in the tax law concerning software we don’t believe it was intended for the high technology industry to suffer a decrease in the tax incentives that are provided and we ask that software be included in the definition of export_property emphasis added id pincite the software industry’s request went unheeded in software industry representatives again attempted to convince congress to amend the fsc rules to clarify that exports of software qualify for fsc benefits that are available to other exports legislation to make such clarification was introduced hearings on h_r before subcomm on select revenue measures house ways and means comm 103d cong lst sess part of - - a software industry representative summarized the industry’s position as follows the failure to permit exports of computer_software to qualify for fsc treatment is counterproductive and inconsistent with the u s interest in fostering the continued growth of this industry in the united_states in addition there is no tax policy reason for denying exporters of software the tax benefits of the fsc rules that are available to other u s exporters and in particular the film and record industries there is a need for congress to clarify the original intent of the disc and fsc legislation to encourage u s exports including software in light of the treasury department’s temporary fsc regulations therefore we respectfully request that congress enact legislation which would clarify that the definition of fsc export_property includes the license of computer_software to foreign distributors and customers with the right to reproduce id pincite statement by james a abrahamson chairman of the board oracle corp on behalf of the fsc software coalition in addition the representative complained that the temporary_regulation adopted a narrow interpretation of the parenthetical exception and denied any fsc benefits for the license of computer_software if the license is accompanied by the right to reproduce the computer_software id pincite these hearings did not result in a change to sec_927 b over the next several years over members of congress requested that the department of the treasury amend the temporary_regulation to explicitly extend fsc benefits to the export of computer_software licenses that include reproduction rights abroad -- p7 - see cong rec sbig_number sbig_number daily ed date statement of sen hatch cong rec h3428 daily ed date statement of rep lantos the department of the treasury maintained that an expansion of the scope of the fsc rules required legislative action cong rec h3428 daily ed date letter from secretary_of_the_treasury bentsen to rep lantos date legislation was introduced to expressly include the sale or licensing of computer_software for use outside the united_states even when accompanied by a right to reproduce within the definition of fsc export_property see cong rec sbig_number sbig_number daily ed date this legislation was not enacted thus sec_927 b remained intact d the parties’ positions the threshold question before us is whether copyrights in computer_software fall within the parenthetical according to respondent the parenthetical describes the narrow subset of copyright_rights that congress intended to save from the general_rule excluding intangibles from export_property the parenthetical describes only copyright_rights in motion pictures and sound_recordings the parenthetical was not intended to and does not refer to copyrights fixed on various media without regard to the nature of the copyrighted content thus respondent maintains that the parenthetical refers to particular kinds of content fixed on the media that are mentioned in the parenthetical and any similar media that might be invented in - - the future reading the statute in a restrictive manner respondent reasons that the phrase ‘similar reproductions’ means similar content on other media not simply any content on similar media respondent maintains that regardless of the medium upon which it is fixed computer_software is neither a motion picture nor a sound_recording according to respondent a computer’s functionality distinguishes computer_software from motion pictures and sound_recordings on the other hand petitioner maintains that computer_software masters are the same as or similar to motion pictures and sound_recording masters thus petitioner asserts that the software masters are similar reproductions to motion pictures and sound_recordings specifically petitioner claims films tapes records as used in sec_927 a b denote tangible media on which images sounds and or other information is recorded and stored these media differ in terms of their specific physical attributes eg a strip of photosensitive cellulose acetate a plastic strip coated with magnetic powder a spiral grooved disc all three types of media however require a machine to read back the recorded content to the consumer or end user in other words they are inherently and necessarily machine-readable media continuing petitioner posits that the phrase similar reproductions within the purview of the parenthetical refers to - - copyrighted work distributed on machine-readable media existing or emergent in addition to films tapes and records to restate the parties’ positions in concluding that copyrights in computer_software do not constitute export_property respondent asserts that films tapes and records are content-- specific and that similar reproductions refers to films tapes and records on media that might be invented in the future conversely in concluding that copyrights in computer_software constitute export_property petitioner asserts that films tapes and records are media-specific denoting the tangible media upon which images sounds and or other information is recorded and stored and that similar reproductions means any information that can be recorded on a recording medium such as reel-to-reel films betamax or vhs videocassettes dvd’s vinyl records reel-to-reel tapes 8-track tapes cassette tapes diskettes hard disk drives and cd’s bk analysi sec_1 statutes as a general_rule patents inventions copyrights and other intangibles are not granted export_property treatment for purposes of fsc benefits rather they are excluded_property sec_927 a b we believe the exception contained in the parenthetical to this general_rule should be narrowly interpreted -- - in our opinion the parenthetical refers to specific kinds of content not any content placed on machine-readable media as petitioner maintains when sec_993 b was enacted in no one could foresee the future media on which films and sound_recordings might be distributed because of this unknown congress included the phrase similar reproductions in the parenthetical reproduction is an exact copy of particular preexisting content fixed on a medium blank tapes are not reproductions of each other but are manufactured copyright concerns content not media indeed a copyright is defined as a property right in an original work of authorship such as a literary musical artistic photographic or film work fixed in any tangible medium of expression giving the holder the exclusive right to reproduce adapt distribute perform and display the work black’s law dictionary 7th ed see u s c sec_102 clearly petitioner does more than distribute blank tapes petitioner’s products are sold because of the content on the medium were we to accept petitioner’s broad interpretation that similar reproductions covers all content on machine-readable media then revenues from the sale or lease of copyrights in practically all products existing and yet to be invented would gualify for fsc benefits the only copyrights congress affirmatively identified as gualifying for export_property treatment were copyrights in motion --- - pictures and sound_recordings when it enacted sec_993 b relating to discs in and sec_927 b relating to fsc’s in the parenthetical in both sections does not explicitly refer to computer_software masters computer_software causes a computer to perform countless functions operating systems software makes a general-purpose computer function by controlling the operation of the computer’s hardware components the execution of applications the sequencing of tasks and the flow of information within the computer system when combined with data and the hardware components of a computer system computer_software enables a computer to enter store process and display information thereby performing specific tasks without software computers cannot function to illustrate if an audio cd is placed in the cd drive of a personal computer it can be played only if a computer_program has been loaded into the computer that instructs the computer how to play the cd an audio cd does not make the computer function the computer_software does removal of the audio cd does not remove the ability of the computer to play a different audio cd yet if the software is not installed the audio cd cannot be played unlike software motion pictures and sound_recordings do not cause a computer to function they are played on machines designed to play them but do not cause the machine to function - - the mere fact that sound or video recordings can be digitally represented does not transform them into computer_software computer_software is fundamentally different from motion pictures and sound_recordings within the purview of the parenthetical films tapes and records are content specific and similar reproductions refers to films tapes and records on media that might be invented in the future in sum we hold that copyrights in computer_software do not constitute sec_927 export_property support for this holding is found in the temporary_regulation to which we now turn our attention interpretation of the temporary_regulation generally temporary regulations have binding effect and are entitled to the same weight as final regulations see 113_tc_309 peterson marital trust v commission102_tc_790 affd 78_f3d_795 2d cir we interpret temporary regulations in toto rather than phrase by phrase see 898_f2d_1435 9th cir the temporary_regulation comports with the language of the statute it succinctly states that although copyrights do not constitute export_property copyrighted articles such as computer_software do qualify as long as the article is not accompanied by a right to reproduce outside the united_states permitting a right - - to reproduce abroad would facilitate reproduction activity outside the united_states that is not the result intended the temporary_regulation contains four sentences the first sentence is virtually identical to the language of the statute it states that intangibles other than certain copyrights are not export_property the introductory clause of the second sentence applies the general_rule that a copyright is not export_property giving books and computer_software as examples of items subject_to the general_rule disqualifying intangibles the second sentence states that a copyrighted_article exported without the right to reproduce for external use is export_property so long as the other requirements are met the third sentence expands upon the second sentence read together the two sentences provide that computer_software on any medium e magnetic tape punched cards or disks if not accompanied by a right to reproduce outside the united_states is export_property by rendering the medium irrelevant the third sentence distinguishes among copyrights based upon their content the fourth sentence is identical to the last sentence of sec_1_993-3 income_tax regs it was therein inserted to address the concern of the sound_recording industry that the parenthetical was not written broadly enough to include its industry practices specific reference to computer_software in the second - -- and third sentences of the temporary_regulation would not have been made in to contradict the fourth sentence which was carried over from sec_1_993-3 income_tax regs to the temporary_regulation according to petitioner computer_software masters are master recording tapes within the purview of the fourth sentence licensed for reproduction outside the united_states and thus constitute export_property we disagree read in context a master recording tape does not include computer_software because the second sentence interprets the general_rule that copyrights are not export_property reproduction in the fourth sentence refers to a copyright transaction described in the second sentence the fourth sentence emphasizes that sound_recording masters fall within the parenthetical and thus are not disqualified by the second sentence contrary to petitioner’s assertion the fourth sentence is not trumped by the second sentence because the fourth sentence concerns a master recording tape whereas the second sentence concerns computer_software and books it was unnecessary to refer to motion pictures in the fourth sentence because the legislative_history reflects that copyrights in motion pictures fall within the exception and the motion picture industry did not lobby for modification petitioner’s interpretation of the fourth sentence would nullify rather than harmonize with other provisions of the temporary_regulation -- - in sum we hold that pursuant to the temporary_regulation copyrighted computer_software with a right to reproduce abroad does not qualify as export_property validity of the temporary_regulation we now turn our attention to petitioner’s alternative argument that the temporary_regulation is invalid the temporary_regulation was promulgated pursuant to the general authority granted to the secretary by sec_7805 not pursuant to specific legislative authority thus it is interpretive see jackson family found v commissioner 97_tc_534 affd 15_f3d_917 9th cir and should be upheld if it is found to ‘ implement the congressional mandate in some reasonable manner’ 411_us_546 quoting 389_us_299 we defer to a regulation if it is a reasonable and permissible interpretation of the statute see eg 523_us_382 440_us_472 it is not our function to decide what the best or most advisable method would be to implement the internal_revenue_code as the supreme court stated in united_states v correll supra pincite congress has delegated to the commissioner not to the courts the task of prescribing ‘all needful rules and regulations for the - - enforcement’ of the internal_revenue_code the delegation helps guarantee that the rules will be written by masters of the subject 95_us_760 in determining whether the secretary’s interpretation of a statute 1s a reasonable one rather than the best or only one see atlantic mut ins co v commissioner supra we are not at liberty to strike down the regulation even if the taxpayer offers a more attractive statutory interpretation see 455_us_16 890_f2d_1329 5th cir the parties agree that the standard in national muffler dealers association inc v united_states supra pincite ’ is appropriate in 440_us_472 states in pertinent part in determining whether a particular regulation carries out the congressional mandate in a proper manner we look to see whether the regulation harmonizes with the plain language of the statute its origin and its purpose a regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent if the regulation dates from a later period the manner in which it evolved merits inquiry other relevant considerations are the length of time the regulation has been in effect the reliance placed on it the consistency of the commissioner’s interpretation and the degree of scrutiny congress has devoted to the regulation during subsequent re-enactments of the statute citations omitted -- - this case by applying that standard we hold that the temporary_regulation is valid our holding is based upon the following the temporary_regulation harmonizes with the purpose of the statute by specifically excluding intangibles from the definition of export_property the purpose of the disc fsc provisions was to increase u s exports and u s jobs by excluding from federal_income_tax certain property sold by an fsc or a disc that was produced manufactured or created in the united_states see staff of joint comm on taxation general explanation of the tax reform act of pincite j comm print the temporary_regulation allows computer_software to be entitled to this exclusion as long as the software is not accompanied by a right to reproduce abroad on the other hand exporting a computer_software master with a right to reproduce abroad sends adaptation localization and manufacturing jobs offshore thus granting fsc benefits to copyrighted computer_software with the right to reproduce abroad would undermine the basic policy of withholding_tax incentives from export transactions that create manufacturing or production jobs overseas petitioner acknowledges that in the event we hold that the parenthetical is restricted to motion pictures and sound_recordings as we have respondent’s construction of the temporary_regulation harmonizes with the statute’s plain meaning -- - petitioner claims that because computer_software involves a creative industry where important jobs are performed in the united_states it belongs in the parenthetical respondent posits that the question is not whether jobs are being performed in the united_states but rather whether jobs that also could be performed in the united_states are moved offshore because copyrights and other intangibles are exported under license we agree with respondent the temporary_regulation reflects congress’ decision not to expand export_property treatment for intangibles beyond copyrights in motion pictures and sound_recordings the and amendments to the disc provisions reflected congress’ continuing concern with the cost and revenue effects of the disc regime despite pleas from the representatives of the software industry for a change in the statutory language to include computer_software as export_property sec_993 b was reenacted’ as sec_927 b without the requested inclusion apparently on the basis that the requested change would not be revenue_neutral and that u s jobs would be moved offshore see 96_tc_903 had congress desired to make fsc benefits available to computer_software copyrights in the fsc legislation replaced many of the tax rules that had been applicable to discs discs were not abolished however their tax benefits were limited and an interest charge on tax-deferred amounts was imposed on disc shareholders see deficit_reduction_act_of_1984 publaw_98_369 sec b 98_stat_494 -- -- it would have specifically done so see eg 511_us_164 474_us_121 congress’ inaction reflects its intent not to grant export_property treatment to computer_software copyrights the temporary_regulation followed congress’ lead congress was aware of the temporary_regulation its treatment of computer_software and the debate thereon congress had the opportunity to amend the statute in light of the temporary_regulation see 103_tc_464 but it did not do so and the inference of congressional approval is strong when legislative_history contains some indication that congress was aware of and approved the administrative construction see central bank v first interstate bank supra pincite the commissioner has consistently denied export_property treatment for computer_software when accompanied by the right to reproduce outside the united_states as early as the comment period leading up to the issuance of sec_1_993-3 income_tax regs and the accompanying technical memorandum see supra note software industry representatives sought a regulation that would include computer_software in the parenthetical the commissioner considered but rejected the industry’s position as evidenced by the omission of computer_software from sec_1_993-3 income_tax - - regs the commissioner again rejected the industry’s position in the temporary_regulation by explicitly excluding computer_software invalidating the temporary_regulation would eradicate the need for copyrights to appear in sec_927 a b because most copyrights would qualify if the parenthetical were to be expanded so as to be based upon the type of medium on which a copyrighted work can be mastered then copyrights in books would qualify in sum the temporary_regulation represents a reasonable accommodation of the competing interests of fairness administrability and avoidance of abuse atlantic mut ins co commissioner u s pincite we believe that the temporary_regulation is a reasonable and permissible interpretation of sec_927 and harmonizes with the language purpose and legislative_history of the statute final matters in reaching our conclusions we have considered all arguments raised by the parties for the sake of completeness we now discuss two arguments that heretofore have not been addressed the parties disagree as to whether the royalties at issue were paid solely for the exploitation of copyright_rights as petitioner maintains or for patents trademark and trade secrets in addition to copyrights rights as respondent maintains petitioner argues that assuming arguendo the royalties it received - al --- from the oem’s and cfc’s were for various types of intellectual_property the payment for rights other than copyrights was de_minimis in light of our holding above that computer_software masters do not fall within the parenthetical we conclude that it is not necessary to decide this issue petitioner maintains that we should interpret the parenthetical in the same manner as the court_of_appeals for the ninth circuit the court to which an appeal in this case would 1ie interpreted the phrase books magazines periodicals films video tapes or other matter for purposes of u s c sec a b in 119_f3d_742 9th cir in that case the court_of_appeals interpreted other matter as follows matter is the physical medium that contains the visual depiction---in this case the hard drive of lacy’s computer and the disks found in his apartment a word is understood by the associated words a general term following more specific terms means that the things embraced in the general term are the same kind as those denoted by the specific terms here the word matter appears at the end of the list books magazines periodicals films and video tapes all of which are physical media capable of containing images citations omitted id pincite lacy wass a criminal case the issue involved therein was whether an individual computer graphics file is other matter pursuant to u s c sec a b the defendant was charged with possessing child pornography he had downloaded computerized - -- visual depictions of child pornography to his computer the statute in question made it a crime to possess or more books magazines periodicals films video tapes or other matter containing the offending depictions u s c a b the court_of_appeals held that because matter appeared at the end of a list of physical media capable of containing images other matter containing any visual depiction of a minor engaging in sexually explicit conduct means a physical medium that contains visual depiction united_states v lacy supra pincite accord 203_f3d_66 1st cir see also 215_f3d_257 2d cir cf 167_f3d_443 8th cir 142_f3d_988 7th cir petitioner’s reliance on lacy is misplaced lacy construed different words within a different statute ina different context it is irrelevant to the issue before us conclusion computer_software does not come within the purview of the parenthetical accordingly we hold that copyrights in computer_software masters are not export_property for purposes of determining sec_924 ftgr’s -- - to reflect the foregoing and the parties’ concessions decision will be entered under rule


t c summary opinion united_states tax_court jason m roach petitioner v commissioner of internal revenue respondent docket no 7430-15s filed date andrew aleman for petitioner molly h donohue and janet f appel for respondent summary opinion guy special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by 1unless otherwise indicated all section references are to the internal continued any other court and this opinion shall not be treated as precedent for any other case respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax for the taxable_year and an accuracy-related_penalty under sec_6662 of dollar_figure petitioner filed a timely petition for redetermination with the court pursuant to sec_6213 at the time the petition was filed petitioner resided in massachusetts after filing an answer to the petition respondent filed with the court a motion for leave to file out of time a first amendment to answer and lodged a first amendment to answer although the court directed petitioner to file an objection if any to respondent’s motion for leave he failed to do so the court subsequently granted respondent’s motion for leave and filed respondent’s first amendment to answer respondent’s first amendment to answer includes affirmative allegations that petitioner failed to report certain wages nonemployee compensation and a state_income_tax refund that he received in and that he failed to substantiate continued revenue code as amended and in effect for and all rule references are to the tax_court rules_of_practice and procedure monetary amounts are rounded to the nearest dollar an otherwise unidentified above-the-line deduction of dollar_figure consequently respondent asserted that petitioner was liable for an dollar_figure increase in his income_tax deficiency for resulting in a total deficiency of dollar_figure and a dollar_figure increase in his accuracy-related_penalty resulting in a total penalty of dollar_figure after concessions the issues remaining for decision are whether petitioner is entitled to dependency_exemption deductions a child_tax_credit and an additional_child_tax_credit for his two minor children and liable for an accuracy-related_penalty under sec_6662 background some of the facts have been stipulated and are so found the stipulation of facts and the accompanying exhibits are incorporated herein by this reference 2petitioner stipulated that for he received but failed to report the following items of income wages of dollar_figure and dollar_figure paid to him by alert ambulance service inc and patriot ambulance inc respectively nonemployee compensation of dollar_figure paid to him by jay’s landscaping and a state_income_tax refund of dollar_figure the parties agree that petitioner is entitled to a reduced deduction of dollar_figure petitioner had claimed a deduction of dollar_figure on line of his tax_return for i general background petitioner has been a firefighter and a paramedic for about years stephanie minardi petitioner’s now former spouse has worked as a paramedic for about years and she became a registered nurse about years ago petitioner and ms minardi met at work in they married in date and have two minor children j m r and k a r ii separation and divorce proceedings in date ms minardi moved out of the marital home and she filed a complaint for divorce in date on date the trial_court of the commonwealth of massachusetts probate and family court department family court issued a temporary order requiring petitioner and ms minardi to comply with a stipulation on temporary orders stipulation the stipulation recited that they would share joint legal and physical custody of the children were relieved of any obligation to pay child_support and would follow a very detailed coparenting plan in addition petitioner was required to maintain health insurance for the children on date ms minardi’s attorney filed a civil complaint for contempt against petitioner alleging inter alia that he had failed to comply with the coparenting schedule described above and that he owed ms minardi dollar_figure as reimbursement for childcare expenses the record does not reflect how the complaint was resolved on date petitioner and ms minardi executed a separation agreement and the family court entered a judgment of divorce nisi which would become absolute on date petitioner agreed to pay weekly child_support of dollar_figure to ms minardi the separation agreement stated that petitioner and ms minardi would file separate tax returns beginning with the taxable_year 3the coparenting plan required petitioner over an eight-week cycle beginning date to provide care for the children as follows during week sec_1 and on monday from a m to p m during week sec_3 through on wednesday from a m to friday pincite p m and during week on monday from a m to p m if by the end of date petitioner and ms minardi had not mutually agreed to a different schedule petitioner would provide care for the children as follows during week sec_1 and on monday from a m to tuesday pincite a m during week sec_3 through on wednesday from a m to saturday pincite a m and during week on monday from a m to tuesday pincite a m and that ms minardi was entitled to claim the children as tax exemptions every year the separation agreement provided that ms minardi would have full legal and physical custody of j m r and k a r and that petitioner was entitled to visitation with the children for four hours on every fifth day of his eight-day work cycle and at other times agreed upon by both parents the separation agreement stated in relevant part however that p rior to the start of that visitation schedule the husband shall visit the children initially for three visits which shall be for an hour at first then progressing by adding an additional hour at each new visit and they shall occur at a mcdonald’s restaurant and that i n order to re- establish a relationship with the children the husband shall make arrangements with a mutually agreed-upon counselor to attend family counseling with the children and visits shall begin when recommended by the counselor iii conflicting testimony petitioner karine roach petitioner’s current spouse and ms minardi testified at trial while petitioner’s and ms minardi’s work schedules were quite demanding the testimony that petitioner and his current spouse offered about the parental care that he provided to his children during the second half of and throughout was directly contradicted by ms minardi petitioner was on call for his primary employer for two 24-hour periods each week ms minardi was on a similar work schedule with her primary employer and she and petitioner both acknowledged working part time for at least one additional employer ms minardi was also studying to become a registered nurse petitioner testified that when ms minardi left the marital home in date the children remained with him and that he provided care for them on average about five days each week through date he explained that he cared for the children when he was not working and that he relied on his girlfriend now ms roach and the wife of another firefighter to care for the children when he was at work ms minardi testified that the children moved with her to a two-bedroom apartment in date that petitioner had two brief visits with the children in the latter part of and that he last visited with them in date ms minardi testified that petitioner did not comply with the coparenting schedules described in detail above that she provided care for the children when she was not working and that she relied on her mother her current husband and a friend to care for the children when she was at work iv petitioner’ sec_2012 tax_return on date petitioner prepared and filed a form_1040 u s individual_income_tax_return for he claimed the filing_status of married_filing_separately reported wage income of dollar_figure claimed four dependency_exemption deductions including exemptions for j m r and k a r a child_tax_credit of dollar_figure and an additional_child_tax_credit of dollar_figure v notice_of_deficiency as previously indicated respondent issued a notice_of_deficiency to petitioner for the taxable_year respondent determined that petitioner is not entitled to dependency_exemption deductions for j m r and k a r reduced the child_tax_credit that petitioner claimed to dollar_figure and disallowed the additional_child_tax_credit discussion as a general_rule the commissioner’s determination of a taxpayer’s liability in a notice_of_deficiency is presumed correct and the taxpayer bears the burden of proving that the determination is incorrect rule a welch v helvering 4the parties stipulated that ms minardi did not execute a form_8332 release revocation of release of claim to exemption for child by custodial_parent releasing her right to claim j m r and k a r as dependents for the taxable_year u s deductions and credits are a matter of legislative grace and the taxpayer bears the burden of proving entitlement to any deduction or credit claimed 308_us_488 petitioner does not contend that the burden_of_proof should shift to respondent pursuant to sec_7491 in any event there is no support in the record for shifting the burden_of_proof in accordance with that provision i dependency_exemption deduction an individual is allowed as a deduction an exemption for each individual who is a dependent as defined in sec_152 of the taxpayer for the taxable_year sec_151 c sec_152 defines the term dependent to include a qualifying_child or a qualifying_relative generally a qualifying_child must bear a specified relationship to the taxpayer eg be the taxpayer’s child have the same principal_place_of_abode as the taxpayer for more than one-half of the taxable_year meet certain age requirements not have provided over one-half of his or her own support for the taxable_year and not have filed a joint_return for that year sec_152 sec_152 generally defines a qualifying_relative as an individual who bears a specified relationship to the taxpayer eg is the taxpayer’s child whose gross_income is less than the exemption_amount with respect to whom the taxpayer provides over one-half of the individual’s support and who is not a qualifying_child of such taxpayer or any other taxpayer at trial petitioner and ms minardi offered contradictory accounts about the parental care that they provided to the children in although petitioner testified that the children resided with him on average about five days per week that year the separation agreement that he executed in date is strong evidence that he did not have a meaningful parental relationship with the children in in particular the settlement agreement limited the time petitioner could visit with the children stated that he needed to take measured steps to reestablish his relationship with them and directed that he consult with a counselor to determine how best to proceed on this record we conclude that petitioner failed to show that j m r and k a r shared the same principal_place_of_abode with him for more than one-half of the taxable_year therefore we sustain respondent’s determination that j m r and k a r were not petitioner’s qualifying children within the meaning of sec_152 although the record indicates that petitioner was required to support j m r and k a r in there is no evidence of the amount of support that he actually provided to them that year because we are unable to determine that petitioner provided over one-half of j m r ’s and k a r ’s support during the year in issue we conclude that they were not petitioner’s qualifying relatives within the meaning of sec_152 sec_152 provides special rules for parents who are divorced separated under a written_separation_agreement or living apart at all times during the last six months of the calendar_year under sec_152 and a noncustodial_parent may treat a child as a qualifying_child or a qualifying_relative if the custodial_parent signs a written declaration conforming with form_8332 indicating that he or she will not claim the child as a dependent for that taxable_year see 139_tc_468 aff’d 745_f3d_890 8th cir sec_152 defines the term custodial_parent as the parent having custody of a child for the greater portion of the calendar_year on this record we conclude that the children were in ms minardi’s custody for the greater portion of the calendar_year and therefore she was the childrens’ custodial_parent it follows that petitioner was the noncustodial_parent of the children see sec_152 because ms minardi did not execute a form_8332 or any other written_statement conforming to its substance we sustain respondent’s determination that petitioner is not entitled to dependency_exemption deductions for j m r and k a r for ii child_tax_credit and additional_child_tax_credit sec_24 provides a tax_credit with respect to each qualifying_child of the taxpayer for whom the taxpayer is allowed a deduction under sec_151 sec_24 defines the term qualifying_child as a qualifying_child of the taxpayer as defined in sec_152 who has not attained age sec_24 provides that a portion of the child_tax_credit commonly referred to as the additional_child_tax_credit may be refundable as previously discussed neither k a r nor j m r is a qualifying_child of petitioner as defined in sec_152 for the taxable_year consequently we sustain respondent’s determination disallowing the portions of the child_tax_credit and additional_child_tax_credit in dispute iii accuracy-related_penalty sec_6662 and b and imposes an accuracy-related_penalty equal to of the amount of any underpayment_of_tax that is due to the taxpayer’s negligence or disregard of rules or regulations or that is attributable to any substantial_understatement_of_income_tax by definition an understatement means the excess of the amount of the tax required to be shown on the return over the amount of the tax imposed which is shown on the return reduced by any rebate sec_6662 an understatement is substantial in the case of an individual if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on the return or dollar_figure sec_6662 with respect to an individual taxpayer’s liability for any penalty sec_7491 places on the commissioner the burden of production thereby requiring the commissioner to come forward with sufficient evidence indicating that it is appropriate to impose the penalty 116_tc_438 once the commissioner meets his burden of production the taxpayer must come forward with persuasive evidence that the commissioner’s determination is incorrect id pincite see rule a welch v helvering u s pincite the commissioner however bears the burden_of_proof in respect of an increased penalty asserted in an amendment to answer rule a petitioner improperly claimed dependency_exemption deductions a child_tax_credit and an additional_child_tax_credit for j m r and k a r for the taxable_year in disregard of applicable statutory provisions additionally petitioner conceded without explanation that he had failed to report several items of taxable_income and that he is not entitled to a portion of a deduction that he claimed on his tax_return resulting in an understatement of income_tax which appears to be in excess of both of the tax required to be shown on the return and dollar_figure sec_6662 consequently we find that respondent met his burden of production in respect of the penalty determined in the notice_of_deficiency and his burden_of_proof in respect of the increased penalty asserted in the amendment to answer petitioner prepared and filed his tax_return for the year in issue he did not offer a defense to the imposition of an accuracy-related_penalty in this case other than to assert that respondent had erred in determining a deficiency that matter having been resolved against him respondent’s determination that petitioner is liable for an accuracy-related_penalty under sec_6662 is sustained to reflect the foregoing decision will be entered under rule


internal_revenue_service number release date index number ------------------------------------- ----------------------------------------------- --------------------------------- ---------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------- id no ------------------- --------------------------------------------------- telephone number ---------------------- refer reply to cc psi plr-112186-16 date date legend x ------------------------------------------- ------------------------------------------------- y ------------------------------------------- ------------------------------ z a ---------------------------------------------------- ---------------------- state ----------------- date1 -------------------- date2 -------------------- date3 date4 ------------------------- ------------------------- date5 --------------------------- date6 -------------------- dear -------------- plr-112186-16 this letter responds to a letter dated date submitted on behalf of x by its authorized representative requesting a ruling under sec_1362 of the internal_revenue_code facts the information submitted states that y was incorporated under the laws of state on date1 x was incorporated under the laws of state on date2 a was the sole shareholder of x and y x and y each elected to be treated as an s_corporation effective date3 a transferred a’s shares in y to x on date4 x elected to treat y as a qualified_subchapter_s_subsidiary qsub effective date4 on date5 as part of a reorganization shares of y were issued to z a corporation wholly owned by a causing y’s qsub election to terminate because it had more than one owner z distributed these shares to a as part of the same reorganization upon discovering the error a transferred these shares of y to x on date6 x represents that there was no tax_avoidance or retroactive tax planning involved in the transfer of shares of y to z a or x in addition x and its shareholder agree to make any adjustments consistent with the treatment of x as an s_corporation and y as a qsub as may be required by the secretary x also represents that x and its shareholder have filed consistently with x’s status as an s_corporation and y’s status as a qsub law and analysis sec_1361 of the code provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year sec_1361 defines a small_business_corporation as a domestic_corporation which is not an ineligible_corporation and which does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than class of stock sec_1361 provides that a qsub shall not be treated as a separate corporation and all assets liabilities and items of income deduction and credit of a qsub shall be treated as assets liabilities and such items as the case may be of the s_corporation sec_1361 defines a qualified_subchapter_s_subsidiary as a domestic_corporation which is not an ineligible_corporation if percent of the stock of the plr-112186-16 corporation is owned by the s_corporation and the s_corporation elects to treat the corporation as a qualified_subchapter_s_subsidiary sec_1362 provides that if an election under sec_1362 or sec_1361 by any corporation was not effective for the taxable_year for which made determined without regard to sec_1362 by reason of a failure to meet the requirements of sec_1361 or to obtain shareholder consents the secretary determines that the circumstances resulting in such ineffectiveness were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness steps were taken so that the corporation for which the election was made is a small_business_corporation or a qsub as the case may be or to acquire the required shareholder consents and the corporation for which the election was made and each person who was a shareholder of the corporation at any time during the period specified pursuant to sec_1362 agree to make the adjustments consistent with the treatment of the corporation as an s_corporation or a qsub as the case may be as may be required by the secretary with respect to this period then notwithstanding the circumstances resulting in such ineffectiveness or termination the corporation shall be treated as an s_corporation or a qsub as the case may be during the period specified by the secretary conclusion based solely on the facts submitted and representations made we conclude that y’s qsub election was terminated on date5 and that the termination was inadvertent within the meaning of sec_1362 consequently we rule that y will be treated as an s_corporation from date5 and thereafter provided that y’s qsub election was otherwise valid and not otherwise terminated under sec_1361 except as specifically ruled above we express or imply no opinion concerning the federal tax consequences of the facts described above under any other provision of the code including whether x is a valid s_corporation and y is otherwise a qsub 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 plr-112186-16 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely laura c fields laura c fields senior technician reviewer office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


tcmemo_2005_132 united_states tax_court robert holliday petitioner v commissioner of internal revenue respondent docket no 18974-03l filed date p filed a petition for judicial review pursuant to sec_6330 i r c in response to a determination by r to proceed with collection by lien of assessed income_tax liabilities for and p filed joint returns with his spouse for these years that reported total income of dollar_figure and a total_tax of dollar_figure on all three of the returns to which were attached identical lengthy documents that contained contentions and arguments that are frivolous and or groundless p filed with the irs a request for a due process hearing to which was attached a document raising several reasons for p’s disagreement with a proposed irs collection action p continues to pursue these issues all of which are refuted by the record and or holdings in prior cases held remanding this matter to respondent’s appeals_office for recording would be neither necessary nor productive held further r may proceed with collection of balances due as determined in a notice_of_determination concerning collection action s under sec_6320 and or robert holliday pro_se jonae a harrison for respondent memorandum opinion nims judge this case arises from a petition for judicial review filed in response to a notice_of_determination concerning collection action s under sec_6320 and or unless otherwise indicated all section references are to sections of 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 this case was submitted fully stipulated pursuant to rule and the facts are so found the stipulation of the parties with accompanying exhibits is incorporated herein by this reference background at the time the petition was filed in this case petitioner resided in phoenix arizona petitioner failed to file timely federal_income_tax returns for and respondent prepared a substitute for return for each year pursuant to sec_6020 and on date respondent mailed to petitioner a notice_of_deficiency for all taxable years see 121_tc_111 n petitioner and his spouse subsequently filed joint returns in for the taxable years and petitioner and his spouse reported total income of dollar_figure and a total_tax of dollar_figure on all of the returns the hollidays also attached a lengthy document to each of the returns that contained arguments that this court has repeatedly found to be frivolous and or groundless see eg copeland v commissioner tcmemo_2003_46 smith v commissioner tcmemo_2003_45 and we find this also to be true in this case see also holliday v commissioner tcmemo_2002_67 affd 57_fedappx_774 9th cir on date respondent issued to petitioner a letter entitled notice_of_federal_tax_lien filing and your right to a hearing under sec_6320 relating to petitioner’s unpaid tax_liabilities for the aforementioned years on date petitioner submitted form request for a collection_due_process_hearing and attached a document which stated in part notice of lien - explanation for disagreement income there was a failure to determine a deficiency there was a failure to issue a notice_of_deficiency there was a failure to generate an assessment list there was a failure of the commissioner to certify and transmit the assessment list there was a failure to record the assessment failure to provide record of assessment and failure to send notice of assessment petitioner later notified respondent that he intended to audio record the administrative hearing respondent’s appeals officer advised petitioner that the hearing could not be recorded on date petitioner attempted to record the scheduled administrative hearing at respondent’s offices in phoenix the appeals officer again informed petitioner that the hearing could not be recorded but offered to conduct the hearing without recording petitioner declined and the hearing ended on date respondent issued to petitioner a notice_of_determination in which the appeals officer recommended proceeding with the lien discussion on date petitioner filed a petition for lien or levy action under sec_6330 citing this court’s holding in 121_tc_8 petitioner contends that respondent’s determination was an abuse_of_discretion because the appeals officer did not permit an audio recording of the administrative hearing petitioner raised a similar contention in response to a motion for summary_judgment filed by respondent before trial for reasons stated in the court’s order of date we denied respondent’s motion allowing the case to proceed to trial however when afforded the opportunity at the time of trial to present meritorious arguments permitted under sec_6330 petitioner chose to submit the case fully stipulated reiterating only the frivolous protester arguments previously rejected in our order of date because the underlying tax_liability is not in dispute we review the appeals officer’s actions under an abuse_of_discretion standard 114_tc_604 114_tc_176 under the abuse_of_discretion standard a determination will be affirmed unless the respondent took action that was arbitrary or capricious lacked sound basis in fact or was not justifiable in light of the facts and circumstances 91_tc_1079 before a lien may be placed on any property or right to property a taxpayer is entitled to notice of intent to file a lien and notice of the right to a fair hearing before an impartial officer of the irs appeals_office sec_6320 and b taxpayers may raise challenges to the appropriateness of collection actions and may make offers of collection alternatives which may include the posting of a bond the substitution of other assets an installment_agreement or an offer-in-compromise sec_6330 the appeals officer must consider those issues verify that the requirements of applicable law and administrative procedures have been met and consider whether any proposed collection action balances the need for the efficient collection_of_taxes with the legitimate concern of the person involved that any collection action be no more intrusive than necessary sec_6330 sec_7521 states that upon the advance request of the taxpayer an internal_revenue_service officer_or_employee shall permit the taxpayer to make an audio recording of any in- person interview relating to the determination or collection of any_tax as explained in our date order in this case in 121_tc_8 this court held that taxpayers are entitled pursuant to sec_7521 to audio record sec_6330 hearings the taxpayer in that case had refused to proceed when denied the opportunity to record and we remanded the case to allow a recorded appeals hearing id in contrast again as noted in our date order we have distinguished and declined to remand cases where the taxpayer had participated in an appeals_office hearing albeit unrecorded and where all issues raised by the taxpayer could be properly decided from the existing record e g id pincite frey v commissioner tcmemo_2004_87 durrenberger v commissioner tcmemo_2004_44 brashear v commissioner tcmemo_2003_196 kemper v commissioner tcmemo_2003_195 stated otherwise cases will not be remanded to appeals nor determinations otherwise invalidated merely on account of the lack of a recording when to do so is not necessary and would not be productive see eg frey v commissioner supra durrenberger v commissioner supra brashear v commissioner supra kemper v commissioner supra see also 117_tc_183 a principal scenario falling short of the necessary or productive standard exists where the taxpayers rely on frivolous or groundless arguments consistently rejected by this and other courts see eg frey v commissioner supra brashear v commissioner supra kemper v commissioner supra because no hearing had been conducted at all in petitioner's case we declined to grant respondent's motion for summary_judgment the record as it then existed did not foreclose the possibility that petitioner might have raised valid arguments had a hearing been held accordingly we provided petitioner an opportunity before the court at the trial session in phoenix to identify any legitimate issues he wished to raise that could warrant further consideration of the merits of his case by the appeals_office or this court petitioner however merely continued to focus on the denial of a recorded hearing and offered no substantive issues of merit hence despite repeated warnings and opportunities the only contentions other than the recorded hearing issue advanced by petitioner ie the notice_of_deficiency and assessment issues discussed below are of a nature previously rejected by this and other courts the record therefore does not indicate that any purpose would be served by remand or additional proceedings the court concludes that all pertinent issues relating to the propriety of the collection determination can be decided through review of the materials before it petitioner claims that there was a failure to issue a notice_of_deficiency or a determination_of_a_deficiency however while a deficiency_notice is not in the record petitioner does not seek to challenge respondent’s determination of his income_tax_liability for the years in issue and agrees that the standard for review in this case is abuse_of_discretion we deem this to be a concession by petitioner that there was a deficiency_notice and a determination_of_a_deficiency notwithstanding petitioner’s assertion to the contrary petitioner alleges irregularity in respondent’s assessment procedure but caselaw establishes that a form_4340 certificate of assessments payments and other specified matters included in the record for each year at issue satisfies the verification requirements under sec_6330 and constitutes presumptive evidence that a tax has been validly assessed see 118_tc_365 ndollar_figure affd 329_f3d_1224 11th cir 115_tc_35 respondent also properly notified petitioner of the assessments by issuing a notice of balance due for each taxable_year see eg 953_f2d_531 9th cir petitioner’s meritless arguments support the conclusion that remanding this matter to respondent’s appeals_office for recording would be neither necessary nor productive and we so hold we have considered all of petitioner’s contentions and arguments that we have not discussed and we find them to be without merit and irrelevant further we hold that respondent correctly determined that collection efforts should proceed to reflect the foregoing decision will be entered for respondent