Opinion ID: 677811
Heading Depth: 1
Heading Rank: 5

Heading: R.C. Sec. 994 provided in relevant part:

Text: Sec. 994. INTER-COMPANY PRICING RULES. (a) IN GENERAL--In the case of a sale of export property to a DISC by a person described in section 482, the taxable income of such DISC and such person shall be based upon a transfer price which would allow such DISC to derive taxable income attributable to such sale (regardless of the sales price actually charged) in an amount which does not exceed the greatest of-- (1) 4 percent of the qualified export receipts on the sale of such property by the DISC plus 10 percent of the export promotion expenses of such DISC attributable to such receipts. (2) 50 percent of the combined taxable income of such DISC and such person which is attributable to the qualified export receipts on such property derived as the result of a sale by the DISC plus 10 percent of the export promotion expenses of such DISC attributable to such receipts, or (3) taxable income based upon the sale price actually charged (but subject to the rules provided in section 482). (b) RULES FOR COMMISSIONS, RENTALS, AND MARGINAL COSTING--The Secretary shall prescribe regulations setting forth-- (1) rules which are consistent with the rules set forth in subsection (a) for the application of this section in the case of commissions, rentals, and other income, and (2) rules for the allocation of expenditures in computing combined taxable income under subsection (a)(2) in those cases where a DISC is seeking to establish or maintain a market for export property. 4 Section 994(b)(2) applied to buy-sell DISCs referred to in Sec. 994(a)(2). Consistent regulations were authorized by Sec. 994(b)(1) for commission DISCs. Furthermore, Treasury Regulation Sec. 1.994-1(d)(2)(i) incorporated commission DISCs in the allocation rules authorized by Sec. 994(b)(2) 5 Section 1.994-1(c)(6)(iii) provided: (iii) Costs (other than cost of goods sold) which shall be treated as relating to gross receipts from sales of export property are (a) the expenses, losses, and other deductions definitely related, and therefore allocated and apportioned, thereto, and (b) a ratable part of any other expenses, losses, or other deductions which are not definitely related to a class of gross income, determined in a manner consistent with the rules set forth in Sec. 1.861-8. 6 Section 1.994-1(c)(6)(iv) provided: (iv) The taxpayer's choice in accordance with subparagraph (7) of this paragraph as to the grouping of transactions shall be controlling, and costs deductible in a taxable year shall be allocated and apportioned to the items or classes of gross income of such taxable year resulting from such grouping. Subparagraph (7) provided in relevant part: (7) 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 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. 7 Sections 861, 862, and 863 of the Code undertake[ ] to classify the sources of income within the United States and without the United States by the nature and location of the activities of the taxpayer or his property which produces the income. Commissioner v. Ferro-Enamel Corp., 134 F.2d 564, 566 (6th Cir.1943) 8 Section 1.861-8(e)(3)(i) provided: (3) Research and experimental expenditures--(i) Allocation--(A) In general. The methods of allocation and apportionment of research and development set forth in this paragraph (e)(3) recognize that research and development is an inherently speculative activity, that findings may contribute unexpected benefits, and that the gross income derived from successful research and development must bear the cost of unsuccessful research and development. Expenditures for research and development which a taxpayer deducts under section 174 shall ordinarily be considered deductions which are definitely related to all income reasonably connected with the relevant broad product category (or categories) of the taxpayer and therefore allocable to all items of gross income as a class (including income from sales, royalties, and dividends) related to such product category (or categories). For purposes of this allocation, the product category (or categories) which a taxpayer may be considered to have shall be limited to the following list. Ordinarily a taxpayer's research and development expenditures may be divided between the relevant product categories. Where research and development is conducted with respect to more than one product category, the taxpayer may aggregate the categories for purposes of allocation and apportionment; however, the taxpayer may not subdivide the categories in this list. Where research and development is not clearly identified with any product category (or categories), it will be considered conducted with respect to all the taxpayer's product categories. The individual products included within each category are enumerated in Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual, 1972 (or later edition, as available). 9 Section 223 stated: SUSPENSION OF REGULATIONS RELATING TO ALLOCATION UNDER SECTION 861 OF RESEARCH AND EXPERIMENTAL EXPENDITURES. (a) 2-YEAR SUSPENSION.--In the case of the taxpayer's first 2 taxable years beginning within 2 years after the date of the enactment of this Act, all research and experimental expenditures (within the meaning of section 174 of the Internal Revenue Code of 1954) which are paid or incurred in such year for research activities conducted in the United States shall be allocated or apportioned to sources with the United States. (b) STUDY-- (1) IN GENERAL.--The Secretary of the Treasury shall conduct a study with respect to the impact which section 1.861-8 of the Internal Revenue Service Regulations would have (A) on research and experimental activities conducted in the United States and (B) on the availability of the foreign tax credit. (2) REPORT.--Not later than the date 6 months after the date of the enactment of this Act, the Secretary of the Treasury shall submit to the Committee on the Ways and Means of the House of Representatives and the Committee on Finance of the Senate a report on the study conducted under paragraph (1) (together with such recommendations as he may deem advisable). 10 National Muffler 's standard, although enunciated well before Chevron U.S.A., Inc. v. National Resources Defense Council, Inc., 467 U.S. 837, 843, 104 S.Ct. 2778, 2782, 81 L.Ed.2d 694 (1984), is still cited with approval. See Cottage Sav. Ass'n, 499 U.S. at 561, 111 S.Ct. at 1508 11 Section 1.861-8(e)(3) was not promulgated pursuant to a specific grant of authority. Its general R & D allocation rules, applicable to multiple operative sections of the Code, were promulgated pursuant to the Commissioner's general grant of authority in I.R.C. Sec. 7805(a). Accord St. Jude Medical, Inc. v. Commissioner, 97 T.C. 457, 483, 1991 WL 221136 (1991). We believe that the standard enunciated in National Muffler for reviewing such interpretive regulations is consistent with the standard enunciated in Chevron 12 Although we quote from the House Report, the Senate Report uses precisely the same language as the House Report 13 We note that Sec. 1.994-1(c)(6)(iii) was promulgated before the 1977 version of Sec. 1.861-8 that is at issue here 14 Section 861(b) provided in relevant part: (b) TAXABLE INCOME FROM SOURCES WITHIN THE UNITED STATES.--From the items of gross income specified in subsection (a) as being income from sources within the United States there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. 15 In making this determination, we have not ignored the length of time the regulation has been in effect. However, in light of its turbulent history, see, e.g., Senate Committee on Finance, 98th Cong., 2d Sess., Explanation of the Provisions Approved by the Committee on March 21, 1984 for the Deficit Reduction Act of 1984 (Comm. Print 1984), we decline to weigh heavily this factor 16 Invalidation of Sec. 1.861-8 as applied to CTI computations does not resolve this issue. Neither invalidation nor suspension of Sec. 1.861-8 absolves St. Jude and International from allocating any of its domestic R & D expenditures to its gross export receipts. See Sec. 1.994-1(c)(6)(iii) (requiring the allocation of definitely related costs). Only if Sec. 223's language mandating allocation or apportionment to sources within the United States applies to CTI computations would the ERTA Moratorium permit the non-allocation of definitely related R & D expenditures 17 Having reviewed materials from both Houses of Congress, we find no substantive conflict in the purpose behind Sec. 223