Addison International appeals the tax court’s two-part decision in
Addison International, Inc. v. Commissioner,
We review do novo the legal standard applied by the tax court in determining whether Addison International failed to qualify as a Domestic International Sales Corporation and whether it was the proper legal taxable entity.
Humana Inc. v. Commissioner,
Addison Products Company, which manufactures heating and air conditioning equipment for commercial and residential use, incorporated Addison International as a Domestic International Sales Corporation in accordance with Internal Revenue Code §§ 991-97 (1954) for the sole purpose of receiving the tax deferral benefits available to a Domestic International Sales Corporation under the statute.
1
On October 1,
On November 30, 1973, Addison International elected Domestic International Sales Corporation status and Addison Products Corporation simultaneously filed its consent to the election. Throughout 1976 and 1977, the years in issue, Addison International maintained a separate bank account at the Detroit Bank and Trust Company and kept separate corporate books and records as required under the Michigan statutes governing corporations. Addison International had no other assets and no separate employees and maintained no office or facilities separate from those owned by Addison Products Corporation. Except for services relating to qualification as a Domestic International Sales Corporation, Addison International performed no services for Addison Products Corporation or anyone else, nor did Addison International request the performance of services from Addison Products Corporation or anyone else. Addison International did not ship goods under its own name and did not issue documents of title or invoices. However, Addison International’s shareholders and officers did hold annual meetings as required under Michigan corporate law.
In organizing and operating Addison International, the officers and directors utilized the “DISC Handbook for Exporters”, issued by the Treasury Department in January of 1972 and explaining how to conduct the affairs of a Domestic International Sales Corporation in such a way as to insure Domestic International Sales Corporation qualification.
During the taxable years of 1976 and 1977, Addison International computed its income under the methods prescribed for Domestic International Sales Corporations under the Internal Revenue Code. 2 Addison International computed its income for the taxable year 1976 under the 50/50 method in accordance with Treas.Reg. § 1.994-l(a) (1954), resulting in income in the amount of $2,185,016, and under the 4% method, as prescribed in Treas.Reg. § 1.994-1 (1954), resulting in income in the amount of $4,730. These amounts were paid by Addison Products Corporation to Addison International as commissions resulting in total commission income of $2,189,746. Income for the taxable year 1977 was computed using the 50/50 method and the 4% method resulting in a total commission income of $2,313,141. In addition to the commission income reported for taxable years 1976 and 1977, Addison International reported interest income derived from a producer’s loan in the amount of $108,591 and $125,626, respectively. Thus, Addison International reported total taxable income for the years in issue in the amounts of $2,292,881 and $2,438,757, respectively.
Addison Products Corporation claimed commission expense deductions attributa
In March 1978, independent auditors informed Addison Product Corporation’s officers and directors that they had failed to follow one of the procedures required to qualify Addison International as a Domestic International Sales Corporation. Specifically, the memorandum from the auditors advised that Treas.Reg. §§ 1.993-2(d)(2) and 1.994-l(e)(3) (1954) were no longer in proposed form but had been promulgated into final form. These regulations required, among other things, that the com-, mission payment made by a related supplier, i.e. Addison Products Corporation, to a Domestic International Sales Corporation, i.e. Addison International, had to be paid within the 60 days following the close of a Domestic International Sales Corporation’s taxable year. The 60-day payment rule had not been included in the handbook relied upon by the officers and directors of Addison International. However, immediately upon learning of the change, Addison Products Corporation made the required payment on March 21, 1978.
The Commissioner issued a timely notice of deficiency to Addison International for the taxable years of 1976 and 1977 on December 15, 1981. The Commissioner did not issue a notice of deficiency to Addison Products Corporation. The statute of limitations with respect to Addison Products Corporation for taxable years 1976 and 1977 expired at midnight on June 30, 1982.
In its notice of deficiency to Addison International, the Commissioner determined that the commissions paid by Addison Products Corporation and reported by Addison International in the taxable years 1976 and 1977 did not constitute qualified export assets as required by the regulations governing a Domestic International Sales Corporation. The amounts had not been paid by Addison Products Corporation to Addison International within 60 days after the close of each taxable year.
4
The
We believe the tax court correctly held that Addison International was not liable for a deficiency for the year 1976 because it was entitled to rely on the handbook issued by the Treasury Department which made no reference to the requirement that Addison Products Corporation pay any commission to Addison International within 60 days of the close of Addison International’s taxable year. As the tax court noted, the handbook itself contained language stating that “the Internal Revenue Service will follow the rules and procedures set forth in this part until such time as they may be modified in regulations or other Treasury publications. Any such modifications which may be adverse to the taxpayers will apply prospectively only.” “DISC: A Handbook for Exporters,” U.S. Department of the Treasury, January, 1972 at 10. The tax court correctly reasoned that because the handbook clearly promised that adverse treatment would not be retroactively applied, Addison International could maintain that it justifiably relied on the handbook immunizing it from retroactive application of the 60-day payment rule. Accordingly, Treas.Reg. §§ 1.993 — 2(d)(3) and 1.994-1(e)(3), which had not been promulgated in final form until October 14,1977, could not be retroactively applied to Addison International. For the taxable year of 1976, Addison International still qualified as a Domestic International Sales Corporation.
See LeCroy Research Systems Corp. v. Commissioner,
For the taxable year of 1977, the tax court found that the commission payment by Addison Products Corporation to Addison International was made on March 21, 1978 after the 60-day payment rule had been promulgated into the final form in Treas.Reg. § 1.994-l(e)(3). The tax court held that Addison Products Corporation and Addison International were aware or should have been aware of Treas.Reg. § 1.993-2(d)(2) which applied the 60-day payment rule to the accounts receivable from commissions to Domestic International Sales Corporations. Therefore, for the taxable year of 1977, Addison Products could not justifiably rely upon the handbook in the face of modification by final rulings made before commission payments by Addison Products to Addison International in March of 1978. 5
The legislative history and the statutory framework governing Domestic International Sales Corporations supports the tax court’s second major holding that Addison International was the proper taxpayer on the income which resulted from Addison International’s disqualification as a Domestic International Sales Corporation in the taxable year of 1977.
The regulations governing a Domestic International Sales Corporation distinguish between three different types of Domestic International Sales Corporation income. A Domestic International Sales Corporation can have “previously taxed income,” “accumulated income,” and “other earnings and profits.” Treas.Reg. § 1.996-3(a). Generally, accumulated income is taxed when actually distributed to shareholders while previously taxed income is taxed at the time it is deemed to have been distributed at the close of the Domestic International Sales Corporation’s taxable year. Other earnings and profits are defined as being income which falls into neither of the two other categories. Treas.Reg. § 1.996-3(d). In examining the legislative history, reference to a Domestic International Sales Corporation’s “other earnings and profits,” indicates that a disqualified Domestic International Sales Corporation should still be treated as a separate corporate entity for the purpose of taxing its “other earnings and profits.” As the tax court noted:
The third division of a [Domestic International Sales Corporation] DISC’S earnings and profits, is referred to as “other earnings and profits.” This has reference to those earnings and profits of a DISC which where accumulated while the corporation was not taxed as a DISC (i.e., in a year prior to the corporation’s election, or subsequent to the election if it did not qualify for the year). These are the “normal” earnings and profits of an ordinary corporation which never was a DISC. As a result, these earnings and profits when distributed are eligible for the dividends received deduction and are not treated as foreign source income. S.Rept. 92-437,1972 C.B. 559 , 628.
Congress intended that a Domestic International Sales Corporation should be treated as a separate entity and current “other earnings income” which was not “previous taxed income” or “accumulated income” should be taxed to the Domestic International Sales Corporation. As the tax court noted, to hold otherwise would, in effect,
The dissenting members of the tax court argue that Addison International, as a disqualified Domestic International Sales Corporation, is a sham corporation and cannot be treated as a separate taxable corporate entity. Once Addison International loses the protection of the statute through disqualification, the only reason for the existence of Addison International is tax avoidance which is not a proper business purpose necessary to establish itself as a separate corporate entity under
Moline Properties v. Commissioner,
The statutory framework also supports the tax court’s conclusion that Congress clearly contemplated the continued corporate status of a disqualified Domestic International Sales Corporation and did not intend to disregard it as if it were a mere shell corporation. Congress prescribed rules regulating the tax treatment of a disqualified Domestic International Sales Corporation in several of the sections of the statute. For example, upon disqualification, a Domestic International Sales Corporation becomes a "former Domestic International Sales Corporation.” Internal Revenue Code § 995 provides that upon disqualification, the former Domestic International Sales Corporation’s accumulated income is taxable to the Domestic International Sales Corporation shareholders. Internal Revenue Code § 995(b)(2)(A). The accumulated income is distributed to the shareholders over a period of up to ten years. Treas.Reg. § 1.995-3(b). Further, a taxpayer’s election to be treated as a Domestic International Sales Corporation remains in effect unless the taxpayer revoked the election or it was disqualified for five consecutive years. Thus, an inadvertent disqualification does not terminate the election. Such a disqualification will prevent the taxpayer from enjoying the benefits of tax deferral in the year of the disqualification but it will not remove its separate corporate status.
Therefore, from the legislative history and the statutory framework of the Internal Revenue Code provisions dealing with Domestic International Sales Corporation, we conclude that Congress intended to treat a former Domestic International Sales Corporation such as Addison International as a corporate entity separate from its parent. Thus, the tax court majority correctly held that a disqualified Domestic International Sales Corporation was meant to be taxed as a separate corporation on any income which was neither previously taxed income nor accumulated income, neither of which were the commissions paid by Addison Products Corporation to Addison International. The current income of a disqualified Domestic International Sales Corporation such as Addison International was taxable to the Domestic International Sales Corporation itself and the dividends, when paid to the shareholders, qualified for the dividends received deduction.
For the reasons stated above, we affirm the decision of the tax court.
Notes
. The Domestic International Sales Corporation provisions were enacted by Congress in 1971 to provide tax deferral for that portion of income earned by United States corporations from the sale or lease of domestic products to foreign buyers and lessees. Generally, a corporation that qualifies as a Domestic International Sales Corporation is not taxed on its profit. Internal Revenue Code §§ 991 and 995(a). Approximately half of the profit of a Domestic International Sales Corporation is taxed as a constructive distribution to the shareholders, whether or not such distribution actually occurs. Taxation on the remaining half is deferred. Internal Revenue Code § 995(b). Any distributions made by the Domestic International Sales Corporation to its shareholders out of previously untaxed earnings and profits are taxable to the shareholders of the Domestic International Sales Corporation. The retained earnings and profit of a Domestic International Sales Corporation that are not taxed currently remain exempt from taxation until they are actually distributed to the shareholders. Internal Revenue Code §§ 996(a)(1), 995(c) and 995(b)(2). Subject to certain restrictions, a Domestic International Sales Corporation is allowed to transfer
. The income computation methods prescribed by Treas.Reg. § 1.994-1 (1954) relate to the proper allocation of income between related entities. Under the 50/50 method the price charged by the parent corporation to the Domestic International Sales Corporation for the export of products may be set at a price which allows the Domestic International Sales Corporation to obtain taxable income up to 50% of the combined taxable income of the parent corporation and the Domestic International Sales Corporation plus 10% of the export promotion expenses. The 4% method allows the parent corporation to set the price charged to the Domestic International Sales Corporation for the exported products at 4% of the qualified export receipts plus 10% of the export promotion expenses incurred by the Domestic International Sales Corporation.
. Under Internal Revenue Code § 6072(b) (1954), a Domestic International Sales Corporation’s tax returns are due on or before the 15th day of the 9th month following the close of its taxable year.
. In order to qualify as a Domestic International Sales Corporation, at least 95% of the adjusted basis of all assets of the corporation, measured on the last day of the taxable year, must be qualified export assets. Internal Revenue Code § 992(a)(1)(B). The term “qualified export asset,” as defined in Internal Revenue Code § 993(b), includes accounts receivables. Internal Revenue Code §§ 1.993-2(a)(3) and 1.993-2(d)(2) (1954) provide generally that a Domestic International Sales Corporation’s accounts receivable will be qualified export assets if the receivables arise as commissions earned by a commission international sales corporation. All parties agree that Addison International was a commission Domestic International Sales Corporation.
Where the domestic parent corporation of the commission Domestic International Sales Corporation is a "related supplier” of the Domestic International Sales Corporation, the circum
. Under the authority of
Gehl Co. v. Commissioner,
The tax court also correctly rejected Addison International’s argument that it should not be disqualified as a Domestic International Sales Corporation as the 60-day payment regulation was invalid because the Commissioner lacked the authority to issue the regulation. The question has been considered on several prior occasions and the regulations were consistently upheld as presenting a proper exercise of the Secretary’s authority.
Gehl Co. v. Commissioner,