Opinion ID: 683244
Heading Depth: 2
Heading Rank: 3

Heading: The Technical Explanation

Text: 47 In 1977, in connection with the Senate ratification proceedings, the Treasury issued a Technical Explanation that stated, inter alia, that the United States foreign tax credit for ACT depended on when the ACT was used to offset mainstream tax in the United Kingdom, and that any credit previously given would be reduced accordingly: 48 1. ACT paid with respect to a distribution shall be treated as attributable to the accumulated profits (determined under U.S. principles) of the year of distribution, except in two circumstances: 49 a) to the extent the ACT reduces mainstream tax for a prior or subsequent year; and 50 b) if, after attribution of ACT which does not reduce mainstream tax, accumulated profits would not exceed corporate taxes for the year. 51 ACT which reduces mainstream tax in any year or years shall be attributable to any accumulated profits of the year or years for which the mainstream tax is reduced. Where ACT is used to offset mainstream tax, the offset will be viewed as a refund of the ACT initially allowed as a credit and as a tax paid in respect of the year for which the ACT is applied as an offset. Consequently, a reduction in the foreign tax credit for the year from which the ACT is carried must be made in accordance with section 905(c) of the Code.... 52 Technical Explanation of the Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains Signed at London, on December 31, 1975, as Amended by the Notes Exchanged at London on April 13, 1976, the Protocol Signed at London on August 26, 1976, and the Second Protocol signed at London on March 31, 1977 (herein Technical Explanation), submitted to the Senate Foreign Relations Committee at hearings held on July 19-20, 1977, reprinted in 1980-81 C.B. at 473-74. 53 This approach was referred to and criticized in general terms in the Senate Executive Report, as quoted supra. Referring specifically to the Technical Explanation, the Report mentioned the difficult and complex issues raised, and declined to adopt or reject the amplifications in the Technical Explanation: 54 The Treasury's technical explanation also set forth a complex set of rules and examples intended to be used for purposes of determining the earnings to which ACT payments by a U.K. corporation are to be attributed for purposes of computing the indirect foreign tax credit.... 55 The ACT refunds, the withholding tax, and the unrefunded portion of the ACT are treated for U.S. foreign tax credit purposes in a manner which is generally favorable to U.S. shareholders. These rules raise difficult and complex issues. In recommending the ratification of the proposed treaty, the Committee does not intend that these rules necessarily serve as a model for future treaties. Further, in recommending the ratification of the treaty, the Committee does not intend to adopt or reject the amplifications of the foreign tax credit rules contained in the Treasury technical explanation. Consequently, Treasury would not be foreclosed by the ratification of the treaty from modifying those administrative interpretations in the future should it deem it advisable to do so. Of course, the rules contained in the treaty also do not limit any legislative action in this area; the computation of the foreign tax credit for unrefunded ACT may be subject to any generally applicable changes in the U.S. foreign tax credit rules which may subsequently be enacted. 56 S.Exec.Rep. No. 95-18 at 36-37, reprinted in 1980-81 C.B. at 429. One may debate the meaning of this cool treatment of the Technical Explanation. What is clear, however, is that the Treasury's position was not embraced by the Senate. That this position is absent from the text of the Treaty is not surprising for, as the negotiators and the Senate recognized, it defeats the stated purpose of avoiding double taxation of the same profits. 57 A treaty must be construed in accordance with the intent of both signatories. Both of the United Kingdom's Ministers for the Treasury averred that they did not accept, or even know of, the position taken in the Technical Explanation: 58 I can say categorically that I was not at any time as Minister or as a Member of the House of Commons shown the Technical Explanation, or briefed on the Technical Explanation or the point at issue in the case. Since I was the responsible Government Minister speaking for the Government in the debates before the House of Commons, I would be the only person to bring any such material before the House of Commons or authorize it to be deposited in the library of the House of Commons. 59       60 [T]he United Kingdom Government did not accept this United States Treasury Technical Explanation of Article 23 either explicitly or implicitly. 61       62 [W]hen the House of Commons approved the Order in Council giving effect to the Treaty as a matter of U.K. domestic law in February 1980, neither it nor I as the Minister responsible had any knowledge, express or implied, of the Technical Explanation. In these circumstances, it is not surprising that the United Kingdom voiced no objection to the Technical Explanation. 63 Affidavit of Lord Rees at 5-8. The Rt. Hon. Denzil Davies averred: 64 I can state from my own knowledge that during the whole of the period when I was a Minister of State responsible for the Treaty, I had no knowledge of and never saw the United States Treasury Technical Explanation of the Treaty in any form. 65       66 [T]he United Kingdom Government of which I was a member and on whose behalf I was the responsible Minister in this matter did not accept the United States Treasury's Technical Explanation either explicitly or implicitly. 67 Affidavit of Rt. Hon. Denzil Davies at 5-6. 68 The government refers to the affidavit of a Treasury employee and member of the United States negotiating team, Steven P. Hannes, who stated that copies of the Technical Explanation would have been sent to the U.K. negotiators. No evidence of such sending was provided, and it must be assumed that the Treasury's files contained no such support. On this extremely one-sided record, it would violate any reasonable canon of construction to infer mutual assent by the signatories to the position taken by the Treasury. D. The Revenue Procedure 69 On the effective date, after the Treaty was ratified by both signatories, the Treasury issued Revenue Procedure 80-18, which introduced a different theory on which to deny the Article 23 credit for ACT, depending on whether the United Kingdom corporation surrendered the Section 85 offset to subsidiaries in the United Kingdom: 70 [F]or U.S. foreign tax credit purposes and pursuant to Article 23, the parent corporation has not paid or accrued the unrefunded ACT [Section 85] offset against the subsidiary's mainstream tax and has contributed to the capital of the subsidiary an amount equal to the unrefunded ACT offset. 71 Rev.Proc. 80-18, Sec. 3.05, reprinted in 1980-1 C.B. at 625. That is, if the British corporation that paid the ACT later surrenders the Section 85 offset to its subsidiaries, Revenue Procedure 80-18 treats that surrender as a contribution to the capital of the subsidiary, and reverses the tax credit previously granted pursuant to Article 23(1)(c). Thereafter, the government argues, ACT is creditable only under Article 23(1)(a). As we shall discuss, this interpretation strains the plain meaning of the treaty. It would also defeat the Treaty purpose of avoiding double taxation. 72 Revenue Procedures do not have the force and effect of Treasury Department Regulations. 1980-81 C.B. at v. See Helvering v. New York Trust Co., 292 U.S. 455, 468, 54 S.Ct. 806, 810, 78 L.Ed. 1361 (1934) (revenue rulings cited by the Commissioner have none of the force or effect of Treasury Decisions and do not commit the Department to any interpretation of law); Spang Industries, Inc. v. United States, 791 F.2d 906, 913 (Fed.Cir.1986) (a revenue ruling is entitled to some weight as reflecting the Commissioner's interpretation of the regulation, but does not have the same force as a regulation); State Bank of Albany v. United States, 530 F.2d 1379, 1382, 209 Ct.Cl. 13 (1976) (It may be helpful in interpreting a statute, but it is not binding on ... the courts.) Thus although the Revenue Procedure warrants fair consideration as reflecting the Treasury's position, it is not insulated from inquiry. 73 The new theory offered in Procedure 80-18 leads to the faulty conclusion that Xerox's credit for the ACT that was paid by RXL on the dividends received by Xerox can be rescinded based on downstream activity within the United Kingdom. The internal disposition of ACT in any of the ways authorized by the Finance Act of 1972 is not relevant to the Section 23 credit. A foreign country's internal procedures do not determine United States tax credit rules, other than as encompassed within a Treaty. United States v. Goodyear Tire & Rubber Co., 493 U.S. 132, 110 S.Ct. 462, 107 L.Ed.2d 449 (1989). A Revenue Procedure can not change the terms and purpose of a treaty. Procedure 80-18, 3 insofar as it would reverse Xerox's entitlement to the Article 23 credit for the ACT that was paid by RXL on the dividends paid to Xerox, is declared void. E. The Competent Authority Agreement 74 A dispute, ambiguity, or uncertainty concerning a treaty is ideally resolved by the signatories themselves. Such a process can provide useful clarification, short of substantive change which would require ratification. The Treaty's Article 25 provides for such a Mutual Agreement Procedure. This procedure was invoked in 1986 at the initiative of the United States with the approval of the Claims Court, while this case was pending. 75 After a period of discussion, an agreed letter from the United States Competent Authority (by delegation of the Secretary of the Treasury, the Competent Authority was the Associate Commissioner (Operations) of the Internal Revenue Service), to the United Kingdom Competent Authority, was issued on December 18, 1986 and accepted on December 23, 1986. The Agreement states, in substantial part: 76 1. It is agreed that Article 23(1)(c) provides a mechanism by which a U.S. foreign tax credit may be obtained for that part of the U.K. tax credit referred to in Article 10(2)(a)(i) which is not paid to a U.S. corporation but to which an individual resident in the United Kingdom would have been entitled had he received the dividend. 77 2. It is agreed that Article 23(1)(c) was included in the Convention for the purpose of ensuring that in accordance with Article 23(1)(a) the Advance Corporation Tax (ACT) payment which generally underlies the U.K. tax credit referred to in paragraph 1 would be treated as an income tax paid to the United Kingdom by the U.K. corporation paying the dividend, because the United States questioned to what extent, in the absence of the Convention, payments of ACT would be treated as payments of a creditable corporate income tax for U.S. foreign tax credit purposes. 78 3. It is agreed that, pursuant to Article 23(1), the Article 23(1)(c) mechanism must be applied in accordance with the provisions and subject to the limitations of the law of the United States and that a credit is to be given under Article 23(1)(c) only for the appropriate amount of tax paid to the United Kingdom. 79 4. It is agreed that Article 23(1) of the convention was not intended to provide two U.S. foreign tax credits for a single payment of ACT to the United Kingdom or U.S. foreign tax credits in excess of the amount of corporation tax (including both ACT and mainstream corporation tax) paid to the United Kingdom in respect of the profits out which a dividend is paid. 80 5. It is agreed that under the language of Article 23(1) which provides that the Article 23(1)(c) credit must be allowed in accordance with the provisions and subject to the limitations of the law of the United States, the timing of the credit is to be determined as a matter of U.S. law. 81 We discern no substantive change from the Treaty provisions. The Agreement summarizes the Treaty purpose and its implementation as applied to the ACT, deplores the taking of double credit in the United States, and confirms that United States law applies to the timing of the credit. Xerox points out that this Agreement did not treat the important aspects of the Treasury's litigation position, such as that the Article 23 credit is only provisional, or that downstream surrender of the Section 85 offset in the United Kingdom permits or requires revocation of the Article 23 credit. 82 The Treasury states that paragraph 5 of the Agreement is important because it provides that United States law determines the timing of the credit, and that Revenue Procedure 80-18 elaborates United States law and thus controls this case. As we have discussed supra, a Revenue Procedure is neither law nor regulation, and is not binding on the courts. The Competent Authority Agreement is silent on the Section 85 offset and the effect of when and how that offset is used in the United Kingdom. This was the main issue in dispute, then and now. The omission from the Agreement of the positions taken in this Revenue Procedure and the earlier Technical Explanation appears to us to emphasize the weaknesses in the government's argument. 83 The Agreement's affirmation that the timing of the tax credit is governed by United States law directs us to the Internal Revenue Code. As we next discuss, the Code allows the United States taxpayer an indirect foreign tax credit for, inter alia, income taxes paid by the foreign corporation on dividends to the United States shareholder, the credit to be taken when the foreign tax is paid or accrued. 84 Finally, there is no issue here of double tax credit in the United States. Although the government devotes a significant portion of its brief to this spectre, it is undisputed that this taxpayer has not received single tax credit, and has made no claim that is suspect on this ground. F. The Internal Revenue Code Provisions 85 A treaty, when ratified, supersedes prior domestic law to the contrary, United States v. Lee Yen Tai, 185 U.S. 213, 220-22, 22 S.Ct. 629, 632-33, 46 L.Ed. 878 (1902), and is equivalent to an act of Congress. However, tacit abrogation of prior law will not be presumed and, unless it is impossible to do so, treaty and law must stand together in harmony. In this case there is easy harmony between the Treaty and the United States law governing foreign tax credits, Secs. 901-906 of the Internal Revenue Code of 1954. 86 In construing the tax law, as for any statute, the starting point is the words of the statute, Bread Political Action Committee v. Federal Election Commission, 455 U.S. 577, 580, 102 S.Ct. 1235, 1237, 71 L.Ed.2d 432 (1982), taking the words in their ordinary meaning in the field of interest, Perrin v. United States, 444 U.S. 37, 42, 100 S.Ct. 311, 314, 62 L.Ed.2d 199 (1979), and giving full effect to every word Congress used. Reiter v. Sonotone Corp., 442 U.S. 330, 339, 99 S.Ct. 2326, 2331, 60 L.Ed.2d 931 (1979). As a special rule in tax cases, if doubt exists as to the construction of a taxing statute, the doubt should be resolved in favor of the taxpayer. Hassett v. Welch, 303 U.S. 303, 314, 58 S.Ct. 559, 565, 82 L.Ed. 858 (1938); Auto-Ordnance Corp. v. United States, 822 F.2d 1566, 1571 (Fed.Cir.1987). 26 U.S.C. Sec. 902 87 Revenue Code Sec. 902 authorizes, inter alia, a tax credit under 26 U.S.C. Sec. 901 for income taxes paid to a foreign government when a domestic corporation owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year. The Treaty, by defining ACT as an income tax, brought ACT within the purview of Sec. 902. In accordance with Sec. 902(a), the domestic corporation shall be deemed to have paid the same proportion of any income ... taxes paid or deemed to be paid by such foreign corporation to any foreign country ... on or with respect to such accumulated profits. Section 902 also includes provisions relating to second and third tier foreign corporations that pay dividends through their parent corporation to the United States corporation. 88 Each party states that Sec. 902 supports its position. The government states that since Sec. 902 permits a tax credit involving second tier foreign corporations, credit for the ACT paid by RXL in 1974 was properly reversed when RXL surrendered the Section 85 offset to its subsidiaries. The government's position is that credit for this ACT can not be allowed to Xerox until each foreign subsidiary up the line distributes dividends to its parent. 89 We do not share this reasoning. The ACT here at issue was for dividends that were paid to Xerox in 1974; the ACT on those dividends was paid by RXL in the United Kingdom in 1974, and was not refundable or reversible. The second-tier RXL subsidiaries did not pay, and had no obligation to pay, the ACT on those dividends. The ACT obligation by RXL was completed in 1974, and was not defeasible by whether, when, or how RXL used its offset rights under United Kingdom law, including whether and when the offset was surrendered to RXL's subsidiaries in the United Kingdom. 90 In accordance with Secs. 901 and 902, Xerox was entitled to the credit when the dividends were distributed to Xerox and the ACT thereon was paid or accrued by RXL, see Sec. 905. The straightforward reading of the Code provisions firmly links the foreign tax credit to the payment to the United States shareholder of dividends on which foreign income tax was paid. In United States v. Goodyear the Court reaffirmed that under Sec. 902 the dividends received by the United States parent must be sourced to the year in which the foreign subsidiary paid the foreign tax, citing Sec. 902's statutory goal of avoiding double taxation. Goodyear, 493 U.S. at 144, 110 S.Ct. at 470. That principle is not served by the government's theory. 91 In view of our conclusion that the conditions now imposed on ACT credits have no support in Sec. 902 and are contrary thereto, we do not reach Xerox's alternative argument that in accordance with Sec. 902 Xerox is entitled to the tax credit even without recourse to the Treaty. 26 U.S.C. Sec. 905 92 The government also relies on Code Section 905, which relates to adjustments to and accounting periods for indirect foreign tax credits. Section 905(a) allows the foreign tax credit to be taken in the year in which the foreign tax accrues, and requires consistency in accounting: 93 Sec. 905(a) Year in which credit taken. 94 The credits provided in this subpart may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year in which the taxes of the foreign country or the possession of the United States accrued, subject, however, to the conditions prescribed in subsection (c). If the taxpayer elects to take such credits in the year in which the taxes of the foreign country or the possession of the United States accrued, the credits for all subsequent years shall be taken on the same basis, and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year. 95 Section 905(c) does not determine entitlement, but authorizes recalculation of the tax credit if the amount of foreign tax is refunded or adjusted after the credit is taken. 96 Sec. 905(c) Adjustments on payment of accrued taxes. 97 If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Secretary or his delegate, who shall redetermine the amount of tax for the year or years affected. The amount of tax due on such redetermination, if any, shall be [paid or credited].... In such redetermination by the Secretary or his delegate of the amount of tax due from the taxpayer for the year or years affected by a refund, the amount of the taxes refunded for which credit has been allowed under this section shall be reduced by the amount of any tax described in section 901 imposed by the foreign country or possession of the United States with respect to such refund; but no credit under this subpart, and no deduction under section 164 (relating to deduction for taxes) shall be allowed for any taxable year with respect to such tax imposed on the refund.... 98 The Court of Federal Claims erred in its reliance on Sec. 905(c) as substantive basis for the withdrawal of credit upon the 1980 surrender by RXL of the Section 85 offset. Section 905(c) indeed permits redetermination of the foreign tax credit when any foreign tax is refunded or adjusted. However, the ACT paid in 1974 was not refunded or adjusted in 1980. The movement of the Section 85 offset from British parent to subsidiary is not a refund or adjustment of the ACT. This tax obligation in the United Kingdom was fixed and paid in 1974, when the dividends were paid to Xerox. It is not refundable, and no adjustment of the 1974 United States tax credit is warranted. Neither Sec. 902 nor Sec. 905 supports the reversal or postponement of credit for the ACT paid by RXL in 1974.