Appeal from a decision of the Tax Court (Fay, Judge) upholding the Commissioner's determination of a deficiency of $84,858 for appellant's fiscal year ending June 30, 1975.
Oakes, Winter and Pratt, Circuit Judges.
LeCroy Research Systems Corporation ("LeCroy") appeals from the decision of the United States Tax Court disqualifying its wholly owned subsidiary LRS Export Corporation ("LRS") as a Domestic International Sales Corporation ("DISC") because commissions owed by LeCroy to LRS were not paid within sixty days of the close of LRS's tax year and thus were not "qualified export assets." The Tax Court affirmed the Commissioner's assessment of a deficiency against LeCroy of $84,858 for LeCroy's tax year ending June 30, 1975. Because we believe the retroactive application of certain regulations promulgated by the Commissioner was unlawful in light of prior assurances given to taxpayers, we reverse.
In 1971, Congress enacted legislation designed to provide tax incentives for domestic corporations to increase their exports by granting them tax deferral benefits similar to those enjoyed by domestic corporations that use foreign subsidiaries to produce and sell goods abroad. See H.R. Rep. No. 533, 92d Cong., 1st Sess. 58, reprinted in 1971 U.S. Code Cong. & Ad. News 1825, 1872; I.R.C. §§ 991-997. Congress's purpose was not simply to remedy the disadvantaged position of domestic corporations as a matter of equity. Rather, the provisions in question were part of a package of revisions of the tax code designed to stimulate economic activity. The DISC provisions in particular were designed to "increase our exports and improve an unfavorable balance of payments." S. Rep. No. 437, 92d Cong., 1st Sess. 1, reprinted in 1971 U.S. Code Cong. & Ad. News 1918, 1918.
A DISC is not subject to federal income tax. Instead, one-half of its earnings are deemed constructive dividends, whether distributed to its shareholders or not, I.R.C. § 995(b), and the rest is not taxable to the shareholders until it is actually distributed or the DISC dissolves or becomes disqualified. See B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders para. 17.14 (4th ed. 1979). Thus, the tax advantage of the DISC is deferral of taxation on approximately one-half of the DISC's export earnings, a benefit intended by Congress to encourage reinvestment of the exempt earnings in export activities.
In January, 1972, shortly after the DISC provisions were enacted, the Secretary of the Treasury issued a Treasury Pamphlet entitled Handbook for Exporters (1972-1 C.B. 679) intended to aid businesses in understanding the DISC provisions. The Handbook consisted of three sections, the first two of which were intended as plain-language overviews of and discussions about DISCs. The third part, "DISC Explained," set forth more technical guidance to potential incorporators of DISCs. The handbook announced that it would follow the rules and procedures set forth under "DISC Explained," "until such time as they may be modified in regulations or other Treasury publications. Any such modifications which may be adverse to taxpayers will apply prospectively only." Although regulations relating to DISC treatment were proposed in 1972, shortly after the Handbook was issued, the final regulations were not adopted until September, 1976.
The term "qualified export asset" is of central importance to achieving the tax benefits since 95% of a corporation's assets must at all times so qualify, I.R.C. § 992(a)(1)(B), or it loses DISC status entirely. This assets test for DISC eligibility was designed by Congress to ensure that the substantial benefits of tax deferral would be related to earnings re-invested in exporting. The Handbook generally provided that accounts receivable arising in connection with the DISC's export transactions were "qualified export assets." It gave as an example DISCs that acted as commission agents on export sales purchasing accounts receivable from the parent principal. It did not, however, expressly state whether an agent's commissions receivable from the principal would be a "qualified export asset." In October, 1972, nearly two years before the DISC in question was formed, the Commissioner published a number of proposed regulations under Section 933 relating to DISCs. Among these was Treas. Reg. § 1.993-2(d)(2), which provided that commissions receivable from the parent to the DISC must be paid within sixty days of the end of the DISC's tax year or lose their status as a "qualified export asset." Many of the proposed DISC regulations went through several revisions, but the sixty day proposal remained constant throughout, although it was moved to I.R.C. § 994 before promulgation in 1976.
LeCroy is engaged in the manufacture and sale of scientific measurement instruments used in the nuclear energy industry. It is an accrual basis taxpayer with a year ending on June 30. In July, 1974, LeCroy formed a wholly owned subsidiary, LRS Export Corporation, incorporated under the laws of New York, as a non-exclusive commissions agent for LeCroy's export sales. LRS is an accrual basis taxpayer with a tax year ending July 31 and timely elected to be treated as a DISC for tax purposes.
Using the accrual method, LeCroy deducted sales commissions as they became payable to LRS pursuant to a non-exclusive commission agency agreement. Similarly, LRS recorded the commissions receivable as income. For LeCroy's fiscal years ending June 30, 1975 and June 30, 1976, LeCroy reported taxable dividends of $10,120 and $92,528, respectively, as Section 995(b) constructive dividends, and deductions for commissions owed to LRS of $186,408 and $239,027. ($18,388 is attributable to the LRS's one month start-up fiscal year of July 1, 1974 to July 31, 1974.) LeCroy did not actually pay the commissions of $20,240 and $184,556 to LRS (the variance is due to the different fiscal years) until April 15, 1975 and April 6, 1976, on or near the fifteenth day of the nine-month period after the close of LRS's tax year, which was the date that LRS's 1974 and 1975 tax returns were due. I.R.C. § 6072(b).
In 1982, the Commissioner sent a notice of deficiency to LeCroy for failure to meet the 95% qualified export assets test for the 1974 and 1975 fiscal years in question because the commissions receivable were not paid by LeCroy to LRS within sixty days of the end of the DISC's tax year as required by Treas. Reg. § 1.994-1(e)(3)(i), which, as noted, had been proposed before, but promulgated after, the transactions in question. Pursuant to I.R.C. § 482, all of LRS's income was reallocated and taxed as income to its parent LeCroy.
LeCroy petitioned the Tax Court for a redetermination of the deficiency. Relying on CWT Farms, Inc. v. Commissioner, 79 T.C. 1054 (1982), the Tax Court held the regulation valid as enacted and as retroactively applied. It approved the reallocation of income to LeCroy as a ...