In this sеcond appeal, the Guam Department of Revenue (“Guam” or “Department”) seeks to assess additional taxes against individual Guam taxpayers based on their sharеs in an S corporation chartered in the Commonwealth of the Northern Mariana Islands (“CNMI”). The district court found that the three-year statute of limitations on the individual Guam return ran frоm the filing of the corporate return in the CNMI, and granted summary judgment. The Department claims on appeal that because Guam and the Marianas
FACTS
The undisputed facts were set forth in full in our earlier opinion,
Holmes v. Director of Revenue and Taxation, Government of Guam I,
On June 14, 1984, the Department disallowed the individual deduction on the grounds that the Subchapter S election was impermissible under Guam law, and alleged a deficiency in the Holmes’ individual return of $42,813. The Holmes filed a petition for redetermination, and stipulated to all material issues of fact. Summary judgment was granted to Guam in 1986.
On appeal, we reversed and remanded, holding that the mirror image tax codes in effect in both Guam and the CNMI made Cable a “domestiс” corporation under Guam law, and determined that allowing the Holmes to deduct the losses of their CNMI Subchapter S corporation on their Guam joint return was not incomрatible with either the Code or the CNMI Covenant.
Holmes I,
While the case was on remand, we held in
Kelley v. Commissioner,
DISCUSSION
The Department concedes that Cable had no legal obligation to file a return with the Territory of Guam, but urges this court to hold that Kelley is inapplicable to independently administered tax jurisdictions such as Guam and the CNMI. In the alternative, the Department also argues that Kelley was wrongly decided and should be overruled.
A grant of summary judgment is normally reviewed de novo.
Kruso v. International Telephone & Telegraph Corp.,
I. Merits
As explained in
Holmes I,
the Internal Revenue Code applies in both Guam and the Marianas through a “mirror image” system under which eaсh jurisdiction administers and collects its own taxes.
Id.,
Holmes I instructs that the “manifestly incompatible” standard is to be construed narrowly. There, we reasoned that allowing Guamanians to enjoy the benefits of Subchapter S election for their CNMI corporations was not incompatible with either the Code or Covenant, but merely flowed from Congress’ decision to allow the two territories to administer their own taxes. The fact that the arrangement may work to the Holmes’ advantage or even allow them a windfall under certain conditions does not constitute “manifest incompatibility.”
Similarly, requiring thе Guam Department of Revenue to abide by the same statute of limitations as the Internal Revenue Service under
Kelley
is not manifestly incompatible with the Code, but merely plaсes the Department on the same footing as the mainland I.R.S.
See
I.R.C. §§ 6037, 6501(a);
Kelley,
The respondent Department attempts to distinguish
Kelley
in two ways. First, it contends that its notice of deficiency was not directed at Cable’s CNMI return, but at the Holmes’ individual return. This argument is merely an attempt to resurrect the claim we rejected in
Kelley,
where we limited individual liability for “flow-through” profits or losses after expiration of the three-year corporate statute of limitations. Because S cоrporations pay no taxes, adjustments are always made on the individual shareholders’ returns, regardless of which jurisdiction is attempting to collect the money. Furthermore, in this рarticular case, the Department has already conducted one audit of the Holmes’ 1980 return, which included the Cable losses, and thus had ample notice of the Holmеs’ intent to claim these deductions well within the three years.
1
This attempt at a “second bite at the apple” is precisely the strategy we rejected in both
Holmes I
and
Kelley. See Kelley,
Secondly, thе Department argues that it has no jurisdiction over CNMI corporations like Cable, and has no access to returns filed in the CNMI. Thus, it reasons, it will never have notice of any deficiencies on individual Guamanian returns and therefore the statute should never begin to run under 26 U.S.C. § 6501(c)(3). Alternatively, it suggests that physical delivery of the CNMI return at the Guam Department be required to trigger the statutory period. 2 However, these arguments are disingenuous. In the case at bar, the Department received actual notice of the Holmes’ intent to deduct Cable’s losses when it received their individual return in 1981, and in fact it audited and disallowed other deductions within the statutory three-year period.
As for future cases, no showing has beеn made that the CNMI Department of Finance refuses to release any information requested by the Guam Department of Revenue; in fact, the two jurisdictions agreed in 1984 to share relevant tax return information. Thus, absent some unusual circumstance, the Department may obtain informational returns filed by CNMI corporations simply by asking, and will be notified of any potential problems merely by
II. Attorney Fees
On appeal, the Holmes request that attorney fees and double costs be awarded as sanctions undеr Fed.R.App.P. 38, and also request an award of fees under 26 U.S.C. § 7430. That section authorizes attorney fees of up to $25,000 and costs to “prevailing parties” who establish that the Government’s position in the litigation was “not substantially justified.” We deny sanctions under Rule 38, as the appeal was not entirely frivolous, but award fees and costs for this appeal under 26 U.S.C. § 7430. No substantial justification existed for Guam’s position on appeal after
Holmes I
and
Kelley. Cf. Bertolino v. Commissioner,
The Department claims that any request for fees under § 7430 must be made to the district court in the first instance. However, the statute refers to “any court proceeding,” and does not limit our jurisdiction to award fees. The Holmes are ordered to file their request and supporting documentation with the Clerk within thirty days as provided by Circuit Rule 39-1.6.
CONCLUSION
We AFFIRM the grant of summary judgment to the Holmes, and GRANT their request for fees under 26 U.S.C. § 7340. The request for sanctions is DENIED.
Notes
. The record includes a “Technical Advice Memorandum," dated May 16, 1983, on the Holmes’ situation, and a document entitled "Income Tax Examination Changes,” dated July 8, 1983. A deficiency of $9,115 was assessed, which the Holmеs paid in full.
. The cases the Department cites in support of this position are wholly inapposite.
See, e.g., Edward Barron Estate Co. v. C.I.R.,
. Of course the Guam legislature is free to rewrite its Territorial Tax Code to avoid such a result, and in fact may now be doing so. See P.L. 20-181.