CCA 9944026: Late foreign corporate returns can bar deductions

Plain-English summary

A U.K. corporation filed its U.S. corporate returns late and sought deductions for the affected years. Chief Counsel advised that the filing deadlines in the regulations under § 882(c)(2) were valid and that late returns could cost the corporation its deductions and credits. It found no general conflict between that rule and the U.S.–U.K. treaty's business profits or nondiscrimination articles. The nondiscrimination question still called for a case-specific review of whether the result was reasonable, with input from the U.S. Competent Authority. Counsel also agreed that the corporation's accounting difficulties after an acquisition did not justify a waiver of the filing deadlines.

Ruling snapshot

• Question: May late Forms 1120-F prevent a foreign corporation from claiming deductions and credits under § 882(c)(2), despite the U.S.–U.K. treaty?
• Outcome: Advice given; the deadlines were valid, subject to case-specific treaty review.
• Key authorities: IRC §§ 882(c)(2), 6072; Treas. Reg. § 1.882-4; U.S.–U.K. income tax treaty, Articles VII and XXIV.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

August 6, 1999

TLBN-890-99
CC:INTL:B1
Number: 199944026
Release Date: 11/5/1999

UILC: 9114.03-42
882.03-00

INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE

MEMORANDUM FOR GERALD A. THORPE, District Counsel Connecticut-Rhode Island District CC:NER:CTR

FROM: W. EDWARD WILLIAMS, Senior Technical Reviewer
Branch 1 (International) CC:INTL:BR.1

SUBJECT:

This Field Service Advice responds to your memorandum dated June 22, 1999. Field Service Advice is not binding on Examination or Appeals and is not a final case determination. This document is not to be used or cited as precedent.

LEGEND:

Taxpayer =
Corporation A =

Year 1
=
Year 2
=
Year 3
=
Date 4
=
Date 5
=
Date 6
=
Date 7
=
Date 8
=
Date 9
=
Date 10
=
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Date 11
=
Date 12
=
I
SSUES:

1. Whether the requirement in I.R.C. ' 882(c)(2) that a foreign corporation file a return
   Ain the manner prescribed by subtitle F@ to get the benefits of deductions and credits
   authorizes the Secretary to impose a timely filing requirement by regulation.

2. Whether I.R.C. ' 882(c)(2), requiring that a return be timely filed by a foreign
   corporation to obtain the benefits of deductions and credits, conflicts with the
   allowance of deductions in the Business Profits Article of the Convention Between
   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
   (hereafter referred to as the United States - United Kingdom Income Tax
   Convention).

3. Whether I.R.C. ' 882(c)(2), requiring that a return be timely filed by a foreign
   corporation to obtain the benefits of deductions and credits, conflicts with the Non-
   Discrimination Article of the United States - United Kingdom Income Tax
   Convention.

CONCLUSIONS:

The timely filing requirement in Treas. Reg. ' 1.882-4(a)(3) is valid as an interpretive regulation because it "carries out the congressional mandate in a proper manner" and "harmonizes with the plain language of the statute, its origin, and its purpose." National Muffler Dealers Ass'n. v. United States, 440 U.S. 472, 476 (1979). I.R.C. ' 882 (c)(2) provides that a foreign corporation may claim deductions (or credits) only if it files "a true and accurate return, in the manner prescribed in Subtitle F.@ The regulations establish the filing deadline by incorporating I.R.C. ' 6072, entitled ATime for filing income tax returns.@ Section 6072 of the Code is contained in Subtitle F. Thus, the regulation=s timely filing requirement Aharmonizes with the plain language of the statute.@ Espinosa v. Commissioner, 107 T.C. 146 (1996), which involved, inter alia, tax years before the effective date of the current regulations, does not lead to the conclusion that Taxpayer is entitled to the deductions claimed on their untimely filed returns for years after the effective date of the regulations. The Tax Court found it unnecessary to opine on the validity of Treas. Reg. ' 1.882-4(a)(3). Moreover, the rationale underlying the Espinosa opinion supports a disallowance of the claimed deductions and credits. 3

Treas. Reg. ' 1.882-4 does not violate Paragraph 3 of Article VII (Business Profits) of the United States - United Kingdom Income Tax Convention. Treas. Reg. ' 1.882-4 is a part of the administrative and procedural framework of the United States tax system within which the provisions of the treaty operate. The timeliness requirement concept embodied in Treas. Reg. '1.882-4 was already a part of the United States= tax administration system when the United States - United Kingdom Income Tax Convention was negotiated and entered into force, and the regulation merely provides Taxpayers with a bright-line application of this concept. Treaties are entered into with the underlying understanding that the provisions of the treaties are subject to the administrative and procedural framework needed for proper administration of each contracting state=s tax system.

Foreign corporations operating in the United States through permanent establishments are not similarly situated to domestic corporations with respect to the Service=s ability to identify and examine noncompliant taxpayers. The timely filing requirement of I.R.C. ' 882(c)(2), as interpreted by Treas. Reg. ' 1.882-4(a), is specifically directed at this difference in circumstances between foreign and domestic taxpayers and, accordingly, application of those provisions, per se, to foreign taxpayers is not discriminatory. Nevertheless, the Non-discrimination Article calls for careful consideration of all the facts and circumstances surrounding the application of the provisions of I.R.C. ' 882(c)(2) in a particular case, including an evaluation of whether or not the results of applying I.R.C. ' 882(c)(2) in the case are reasonable and whether or not the relevant treaty partner would view those results to be consistent with its understanding of the role of administrative procedures applicable to permanent establishments. The Competent Authority would be in the best position to evaluate these facts and circumstances for this purpose.

FACTS:

Taxpayer acquired Corporation A, a United Kingdom corporation, on Date 4. Since that date, Corporation A, a calendar year taxpayer with a place of business in the U.S., consistently filed its Forms 1120F delinquently .

Taxpayer=s Year 1 and Year 2 consolidated federal income tax returns are under examination. On Date 5, the Examination Team issued an IDR requesting all Forms 1120F filed for Year 1 and Year 2. Taxpayer submitted filed Forms 1120F for all its subsidiaries except the Year 2 Corporation A return. Taxpayer stated that Corporation A=s Year 2 Form 1120F, with a due date of Date 6 was not yet filed. Thereafter, each month the team asked Taxpayer to submit Corporation A's delinquent Year 2 Form 1120F. Subsequently, Corporation A's Year 3 return became due on Date 7 but was not filed. Since Corporation A's Year 2 and Year 3 returns were not filed, the team issued a second IDR, on Date 8, 4

requesting these returns. Although Taxpayer agreed to provide the returns by Date 9, it failed to do so, and ultimately submitted Corporation A's 1995 and 1996 Forms 1120F on Date 10.

Taxpayer does not claim that Corporation A's Year 2 and Year 3 returns were timely filed and blames the delinquency on problems encountered after Corporation A's acquisition in Year 2. Specifically, according to Taxpayer, financial accounting for Corporation A after acquisition was substantially different than its pre-acquisition accounting, making gathering the information necessary to prepare the returns difficult. It contends that this problem was compounded by the fact that after the acquisition, Corporation A had no financial accounting personnel to gather the data. Taxpayer states that the data was finally obtained in Date 10 and a consultant was hired in Date 11 to prepare the returns.

Taxpayer further claims that the time limits imposed by Treas. Reg. ' 1.882-4 are invalid as they are outside the scope of the regulatory authority of section 882 and Subtitle F. It also claims that the regulation is rendered invalid in this case because it is inconsistent with the Business Profits and Non-Discrimination Articles of the income tax treaty between the United States and the United Kingdom.

LAW AND ANALYSIS

ISSUE 1

Treas. Reg. ' 1.882-4(a)(2) is Valid as an Interpretative Regulation

I.R.C. ' 882(c)(2) generally provides that a foreign corporation may claim deductions (and credits) only if it files "a true and accurate return, in the manner prescribed in Subtitle F, including therein all the information which the Secretary may deem necessary for the calculation of such deductions or credits."

Treas. Reg. ' 1.882-4(a)(2) provides in part that:

A foreign corporation shall receive the benefit of the deductions and credits otherwise allowed to it with respect to the income tax, only if it timely files or causes to be filed with the Philadelphia Service Center, in the manner prescribed by subtitle F, a true and accurate return of its taxable income which is effectively connected, or treated as effectively connected, for the taxable year with the conduct of a trade or business in the United States by that corporation.
 5

Treas. Reg. ' 1.882-4(a)(3) provides that whether a return for a particular taxable year is considered filed on a timely basis will depend on whether the foreign corporation filed a return for the immediately preceding taxable year-

A. If a return was filed for the immediately preceding taxable year, or if the taxable year in question is the first taxable year for which a return is required to be filed, then the return must be filed within 18 months of the due date set forth in I.R.C. ' 6072 and the underlying regulations.

B. If no return was filed for the immediately preceding taxable year, and the taxable year in question is not the first taxable year for which a return is required to be filed, then the return must be filed no later than the earlier of (i) 18 months of the due date set forth in I.R.C. ' 6072 or (ii) the date the IRS mails a notice to the foreign corporation advising the corporation that the tax return has not been filed and that no deductions or credits (with a few exceptions not relevant here) may be claimed by the Taxpayer.

Treas. Reg. ' 1.882-4 was proposed in its present form in July 1989 and was adopted in December 1990. The prior version of Treas. Reg. ' 1.882-4 did not have an express provision conditioning the allowance of deductions to a foreign corporation on the filing of a timely return. The preamble to current Treas. Reg. '1.882-4 states:

Commentators questioned the validity of the filing deadlines as set forth in the proposed regulations. The filing deadlines were not eliminated in the final regulations, however, since the statute clearly provides for the denial of deductions and credits if returns are not filed in a timely manner. This requirement is justified because of the different administrative and compliance concerns with regard to nonresident alien individuals and foreign corporations.

T.D. 8322, 1990-2 C.B. 172.

In determining the degree of deference accorded to regulations promulgated by administrative agencies, courts traditionally have distinguished between regulations that are "legislative,@ and those that are "interpretative." Legislative regulations are those issued pursuant to a specific grant of authority to define a statutory term or prescribe a method of executing a statutory provision. Rowan Cos. v. United States, 452 U.S. 247, 253 (1981); Batterton v. Francis, 432 U.S. 416, 425 (1977). Legislative regulations "are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute." E.I. du Pont de Nemours v. Commissioner, 41 F.3d 130, 135 (3rd Cir. 1994), aff=g 102 T.C. 1 (1994), quoting Chevron U.S.A. Inc. v. Natural Resources Defense 6

Council, Inc., 467 U.S. 837, 844 (1984). By contrast, interpretative regulations are issued under the general grant of authority found in I.R.C. ' 7805(a), which empowers the Secretary to adopt all "needful rules and regulations" for the enforcement of the internal revenue laws. E.I. du Pont de Nemours 41 F.3d at 135. The Commissioner's interpretations set forth in the regulations can be measured against a specific provision of the Code, and thus are given less deference than a legislative regulation. Rowan Cos; E.I. du Pont de Nemours (A[i]n the tax area, we are still required to treat regulations issued under a general grant of authority with broad deference, although to a somewhat lesser degree than when Congress has made a specific delegation of authority in a specific statute"). In this regard, an interpretative regulation will pass muster if it "carries out the congressional mandate in a proper manner" and "harmonizes with the plain language of the statute, its origin, and its purpose." National Muffler Dealers Ass'n. v. United States, 440 U.S. 472, 476 (1979). The regulation must be sustained unless unreasonable and plainly inconsistent with the revenue statutes; it should not be overruled except for weighty reasons. Bingler v. Johnson, 394 U.S. 741, 750 (1969); Commissioner v. South Texas Lumber Co., 333 U.S. 496, 501 (1948). See also, United States v. Correll, 389 U.S. 299, 307 (1967); Rowan Cos.; New Jersey v. Department of Health and Human Services, 670 F.2d 1262, 1282-83 (3d Cir. 1981); Pacific First Federal Savings Bank v. Commissioner, 961 F.2d 800, 803-804 (9th Cir. 1992). The deference given to interpretative regulations by the courts is a reflection of the principle that "Congress has delegated to the Secretary of the Treasury, not to [the courts], the task of, administering the tax laws of the Nation."' Commissioner v. Portland Cement Co. of Utah, 450 U.S. 156, 169 (1981), quoting United States v. Cartwright, 411 U.S. 546, 550 (1973). For a recent Tax Court opinion discussing the standard of review applicable to legislative and interpretative regulations, see Central Pennsylvania Savings Association and Subsidiaries v. Commissioner, 104 T.C. 384 (1995).

In this case, the timely filing requirement set forth in Treas. Reg. ' 1.882-4(a)(3) is an interpretive regulation because it was not issued pursuant to a specific grant of authority but under the general grant of authority found in I.R.C. ' 7805(a). The timeliness requirement in Treas. Reg. ' 1.882-4(a)(3) is valid as an interpretive regulation because it "carries out the congressional mandate in a proper manner" and "harmonizes with the plain language of the statute, its origin, and its purpose." National Muffler Dealers Ass'n., 440 U.S. at 477.

I.R.C. ' 882(c)(2) provides that a foreign corporation may claim deductions (and credits) only if it files "a true and accurate return, in the manner prescribed in Subtitle F.@ The regulations establish the filing deadline by incorporating I.R.C. ' 6072, entitled ATime for filing income tax returns.@ Section 6072 of the Code is contained in Subtitle F. Thus, 7

the regulation=s timeliness requirement Aharmonizes with the plain language of the statute.@ National Muffler Dealers Ass'n., 440 U.S. at 477.

Moreover, the timeliness requirement in the regulation Acarries out the congressional mandate in a proper manner consistent with its origin and purpose.@ Courts consistently found that, with respect to section 233 of the 1939 Code (the predecessor to current section 882(c)(2)), there is a Aterminal point@ after which a taxpayer can no longer claim the benefit of deductions by filing a return. Blenheim Co., Ltd. v. Commissioner, 125 F.2d 906 (4th Cir. 1942), aff=g 42 B.T.A. 1248 (1940). Taylor Securities, Inc. v. Commissioner, 40 B.T.A. 696 (1939). In Blenheim Co., the court stated:

This terminal date, which the Board of Tax Appeals first adopted in Taylor Securities v. Commissioner, 1939, 40 B.T.A. 696, is directed against those foreign corporations which instead of being induced voluntarily to advise the Commissioner of their domestic operations, might find their interests best served by filing no return whatever, and then waiting until such time, if any, as the Commissioner discovers their existence and acquires sufficient information about their income on which to base a return. Unless they are precluded from then obtaining the deductions and credits under such circumstances, such foreign corporations can, if detected, come in for the first time after the Commissioner has made a return and suffer no economic loss other than the general 25% late filing penalty which applies to domestic as well as foreign corporations.

Id. at 910.

The court further observed that the fact that Congress intended for the condition in Section 233 to be strictly applied is apparent from the use of the limitation Aonly.@ The court noted:

The difficulty here encountered by the Commissioner in attempting to ascertain the petitioner=s correct income tax is a striking example of the many administrative problems inherent in the application of the federal income tax to foreign corporations. This has prompted Congress to impose special conditions on such corporations. Indeed, unless a foreign corporation is induced voluntarily to advise the Commissioner of all of its income attributable to sources within the United States and of the exact nature of all deductions from such income, the Commissioner may never learn even of the corporation=s existence, and, in any event, he will probably be unable to determine the correct amount of its taxable income. ... The situation is pregnant with possibilities of tax evasion. In express recognition of this fertile danger to the orderly administration of the income tax as applied to foreign 8

corporations, Congress conditioned its grant of deduction on the timely filing of true, proper and complete returns. ... The conclusion that the preparation of a return by the Commissioner a reasonable time after the date it was due terminates the period in which the Taxpayer may enjoy the privilege of receiving deductions by filing its own return, is consistent not only with the intention of Congress as evidenced by the legislative history of Section 233, but also with consideration of sound administrative procedure.

Id. at 909-10 (Emphasis in the original).

The issue in Espinosa v. Commissioner, 107 T.C. 146 (1996), was whether the untimely returns filed by a non-resident alien individual, after the Commissioner notified the Taxpayer that substitute returns had been prepared but before a statutory notice of deficiency was issued, were sufficient to avoid the disallowance of deductions under I.R.C. ' 874(a). The Tax Court in Espinosa rejected the petitioner=s argument that it could avoid the effect of I.R.C. ' 874(a) by filing returns prior to issuance of a statutory notice of deficiency for years prior to the effective date of Treas. Reg. '1.874-1(b)(1) (years 1987 through 1989). The Tax Court concluded that where the petitioner did not respond to the Commissioner=s letters dated November 13, 1992, January 12 and February 3, 1993, and waited seven months to file returns after the letter dated March 23, 1993, the Taxpayer could not avoid the disallowance of deductions under section 874 (a). 107 T.C. at 156-158. The Espinosa court stated:

[W]hile sections 874 (a) and 882(c)(2) contain no explicit time limit, the policy behind these provisions, as applied by the case law, dictates that there is a cut-off point or terminal date after which it is too late to submit a tax return and claim the benefit of deductions. If no cut- off point existed, Taxpayers would have an indefinite time to file a return, and these provisions would be rendered meaningless. [Emphasis added.]

Id. at 157.

The Espinosa court further stated that to hold otherwise would render the entire provisions of the statute a nullity. Id., citing Gladstone Co. v. Commissioner, 35 B.T.A.
764, 768 (1937)). With respect to tax years 1990 and 1991, the Tax Court in Espinosa found it unnecessary to address the petitioner=s argument that Treas. Reg. ' 1.874-1(b) was invalid. Instead, the Tax Court upheld the Commissioner=s disallowance of deductions based on I.R.C. ' 874 and the existing case law. Thus, the rationale underlying the Espinosa opinion supports a disallowance of the claimed deductions and credits. See also Inverworld, Inc. v. Commissioner, T.C. Memo 1997-226 (Tax Court disallowed Cayman Corporation=s claimed deductions from its I.R.C. ' 882 income for failing to file Atimely, true and accurate@ returns).

ISSUE 2
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I.R.C. ' 882 and the United States - United Kingdom Income Tax Convention are not Inconsistent

The Taxpayer argues that Paragraph 3 of Article VII (Business Profits) of the United States - United Kingdom Income Tax Convention entitles it to deductions and that the treaty contains no requirement for the filing of a timely return. Since the predecessor to I.R.C. ' 882 and the United States - United Kingdom Income Tax Convention are inconsistent, under the later in time rule of I.R.C. ' 7852 the Treaty provisions control. Thus, in essence, Taxpayer argues that Treas. Reg. ' 1.882-4 violates the treaty. We disagree.

Section 7852(d)(1) provides:

For purposes of determining the relationship between a provision of a treaty and any law of the United States affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being a treaty or a law.

The legislative history of this provision, as reflected in the Senate Finance Committee Report, provides that this provision was intended to adopt a general rule that the later in time of a statute or a treaty controls. S. Rept. 100-445, 100th Cong., 2d Sess. at 316 (1988). However, the Senate Finance Committee Report also provides that the section 7852(d)(1) later in time rule only applies where there is a conflict between the law and the treaty. Id. Further, there is generally a presumption of harmony between earlier and later promulgations, and every attempt should be made to harmonize the application of the treaty with tax legislation. Id.; Estate of Burghardt v. Commissioner, 80 T.C. 705, 713-716 (1983); Mudry v. United States, 11 Cl.Ct. 207, 211-212 (1986). The Senate Finance Committee Report to section 7852(d)(1) provides:

It is a proper function of the courts to carry out the process of harmonization, that is, to construe earlier and later provisions in a way that is consistent with the intent of each and that results in an absence of conflict between the two.

S. REPT. NO. 1445, 100th Cong., 2d Sess. at 317. The Senate Finance Committee Report further provides:

Courts may find convincing evidence that the purpose of the later statute was completely unrelated to the earlier provision purported to be repealed, and that therefore the earlier provision continues to apply without change.

Id., citing Watt v. Alaska, 451 U.S. 259; United States v. United Continental Tuna Corp., 425 U.S. 164 (1976). 10

In addition, the Acardinal rule@ to statutory construction Ais that repeals by implication are not favored.@ Pasadas v. National City Bank, 296 U.S. 497, 503 (1936); see also Zenith Radio Corp. v. Matsuhita Elec. Indus. Co., 494 F. Supp. 1263, 1265 (1980); Tennessee Valley Authority v. Hill, 437 U.S. 153, 189 (1978); United States v. United Continental Tuna Corp., 425 U.S. 164, 168 (1976); Georgia v. Pennsylvania Railroad Co., 324 U.S. 439, 456-457 (1945). Repeal by implication is permitted only when the earlier and later laws are irreconcilable, which requires a clear repugnancy between the two. See Georgia v. Pennsylvania Railroad Co., 324 U.S. at 439; Morton v. Mancari, 417 U.S. 535 (1974); Zenith, 494 F. Supp at 1267. AThe courts are not at liberty to pick and choose among congressional enactments, and when two statutes are capable of co-existence, it is the duty of the courts, absent a clearly expressed congressional intention to the contrary, to regard each as effective.@ Morton v. Mancari, at 551; see also Zenith, 494 F. Supp. at 1266 (finding Ain order for a subsequent enactment of Congress to constitute an implied repeal of an earlier statute, the intention of the legislature to repeal must be >clear and manifest=@).

Treas. Reg. ' 1.882-4 is a part of the administrative and procedural framework of the United States tax system within which the provisions of the treaty operate. The timeliness requirement concept embodied in the regulation was already a part of the United States= tax administration system when the United States - United Kingdom Income Tax Convention was negotiated, and the regulation merely provides Taxpayers with a bright-line application of this concept. Treaties are entered into with the underlying understanding that the provisions of the treaties are subject to the administrative and procedural framework needed for proper administration of each contracting state=s tax system.

Paragraph 3 of Article VII (Business Profits) of the United States - United Kingdom Income Tax Convention provides:

In determining the business profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere.

The Treasury Department=s Technical Explanation to Paragraph 3 of Article VII (Business Profits) provides in part:
under paragraph (3), expenses, wherever incurred, which are reasonably connected with profits attributable to the permanent establishment, including 11

a reasonable allocation of executive and general administrative expenses, research and development expenses, interest and other expenses incurred for the enterprise as a whole (or the part which includes the permanent establishment) will be allowed as deductions in determining the business profits as a whole.

The United States - United Kingdom Income Tax Convention was signed on December 31, 1975, and brought into force on April 25, 1980.

The denial of deductions under Treasury Regulation section 1.882-4(a)(3)(i), pursuant to I.R.C. ' 882(c)(2), violates Article VII (Business Profits) of the United States - United Kingdom Income Tax Convention only if application of the regulation to the Taxpayer is inconsistent with the intent of the parties and the purpose of the specific treaty provision. Every attempt should be made to harmonize the application of the treaty with tax legislation. Estate of Burghardt v. Commissioner, 80 T.C. 705, 713-716 (1983); Mundry v. United States, 11 CI.Ct. 207, 211-212 (1986). The goal of treaty interpretation is to give the specific words of a treaty a meaning consistent with the genuine shared expectations of the contracting parties. Maximov v. United States, 299 F.2d 565, 568 (2d Cir. 1962), affd., 373 U.S. 49 (1963); see also United States v. Stuart, 489 U.S. 353 (1989) (the literal terms of a convention must be interpreted consistently with the expectations and intentions of the United States in entering into the income tax convention). In interpreting treaties, courts will first look to the plain meaning of the language of the treaty. Sumitomo Shoji Am., Inc. v. Avaliano, 457 U.S. 176, 180 (1982). Where the plain meaning of the language of the treaty is ambiguous or silent on a point, courts will look to extrinsic materials. See Tseng v. El Al Israel Airlines, Ltd., 122 F.3d 99 (2d. Cir. 1997) ("Treaties are construed more liberally than private agreements, and to ascertain their meaning we may look beyond the written words to the history of the treaty, the negotiations, and the practical construction adopted by the parties," citing Choctaw Nation of Indians v. United States, 318 U.S. 423, 431-32 (1943); see also Vienna Convention on the Law of Treaties art. 32, U.N. Doc. A/CONF. 39/27 (1969), reprinted in 63 Am. J. Int'l L. 875, 885 (1969) (it is appropriate to use supplementary materials to "confirm the meaning resulting from" a contextual reading of the treaty's plain language)).

The role of the Business Profits Article is to ensure the proper allocation of the profits of a resident of a contracting state between its country of residence and the other contracting state where the resident does business through a permanent establishment; it is not intended to include administrative provisions such as filing requirements. Section 882(c)(2) and Treas. Reg. ' 1.882-4 are not intended to allocate items of income and expenses between Corporation A=s U.S. permanent establishment and Taxpayer=s operations. I.R.C. ' 882(c)(2), as interpreted by Treas. Reg. ' 1.882-4, sets forth a 12

reasonable period of time for foreign corporations to assess whether they are engaged in a trade or business in the United States and to file either a complete return or alternatively, a protective return pursuant to Treas. Reg. ' 1.882-4(a)(3)(iv). Nor is the Business Profits Article intended to override administrative provisions under the domestic law of a contracting state that are necessary to ensure tax compliance.

Section 233, the predecessor to I.R.C. ' 882(c)(2), dates back to the Revenue Act of
1928. The United States - United Kingdom Income Tax Convention at issue here was brought into force on April 25, 1980. Thus, the United States government=s position that a timeliness requirement was implicit in I.R.C. ' 882(c)(2), and its predecessor section 233, was well established at the time the United States - United Kingdom Income Tax Convention was negotiated and entered into force. Taylor Securities, Inc. v. Commissioner, 40 B.T.A. 696 (1939); Blenheim Co., Ltd. v. Commissioner, 125 F.2d 906 (4th Cir. 1942); Georday Enterprises, Ltd. v. Commissioner, 126 F.2d 384 (4th Cir. 1942). By the time the United States - United Kingdom Income Tax Convention was negotiated, it was also an established principle of U.S. tax law that in order to encourage compliance with, and to facilitate proper administration of, the U.S. tax system vis-a-vis foreign corporations it was necessary to have a terminal point after which deductions would not be allowed, even if a Taxpayer files a true and accurate return after that point. Taylor Securities, Inc. v. Commissioner, 40 B.T.A. 696 (1939); Blenheim Co., Ltd. v. Commissioner, 125 F.2d 906 (4th Cir. 1942); Georday Enterprises, Ltd. v. Commissioner, 126 F.2d 384 (4th Cir. 1942). In addition, the timeliness requirements in the regulations were set forth in the proposed regulations, which were published on July 31, 1989, 1989-2 C.B. 823. The United States - United Kingdom Income Tax Convention was signed on December 31, 1975. Had the parties intended that the regulations not apply to taxpayers covered by the Convention, the expression of that intent would have been made.

One need only peruse the entire Article 7 to conclude that its purpose is to define the

general nature of profits to be taxable to a permanent establishment, and the deductions to be allowed. There is no language to suggest that the contracting states intended to address their respective administrative filing requirements. Had it been the intention of the contracting states to override I.R.C. ' 882(c)(2), and the regulations thereunder, Ait would have been very easy to have declared the purpose in unmistakable terms@ when they drafted Article 7 Paragraph 3. Having failed to do so, long-standing rules of construction mandate that there is no implied repeal of I.R.C. ' 882(c)(2) or its regulations. Tennessee Valley Authority v. Hill, 437 U.S. 153, 189-90 (1978); Morton v. Mancari, 417 U.S. 535, 549-51 (1974).

The above analysis is supported by the Commentary to Article 7(1) of the 1977 OECD Model Tax Convention on Income and Capital, which is substantially identical to Article VII 13

Paragraph 1 of the United States - United Kingdom Income Tax Convention. The allocation provisions in the Article are not intended:
to sanction any such malpractice [i.e., the undisclosed channeling of profits away from a permanent establishment], or to shelter any concern thus evading tax from the consequences that would follow from detection by the fiscal authorities concerned. It is fully recognised that Contracting States should be free to use all methods at their disposal to fight fiscal evasion.
[Emphasis added.] (Paragraph 1.8).

In addition, the Commentary to Article 7(3) confirms that its purpose is to define the general nature of profits and deductions to be considered in the taxation of a permanent establishment. Paragraph (3) Aclarifies, in relation to the expenses of a permanent establishment, the general directive laid down in paragraph 2.@ The entire Commentary to Paragraph 3 gives examples that address the nature of deductions, without reference to administrative methods to combat evasion.

Further, Paragraphs 7 through 10 of the 1977 OECD Commentary to Article 1 address Aimproper use of the Convention.@ Paragraph 7 provides that tax conventions should not be used to help tax avoidance or evasion. Paragraph 7 further provides that individual states should adopt laws targeting abusive transactions and should ensure that the language or their bilateral income tax treaties do not nullify these domestic rules. The Commentaries to Article 1 of the 1992 and 1998 OECD Conventions adopt the language of Paragraphs 7 through 10 of the 1977 OECD Commentary to Article 1.

Additionally, the 1992 and 1998 OECD Commentaries to Article 1 provide, in Paragraphs 11 through 26, further Commentary that clarifies the scope of the basic rules of Paragraphs 7 through 10. Paragraph 22 of the OECD Commentaries to Article 1 provides that different forms of tax treaty abuse were considered along with possible ways to deal with them such as Asubstance-over-form@ rules and Asubpart F type@ provisions. Paragraph 23 specifically provides, in part:

The large majority of OECD Member countries consider that such measures are part of the basic domestic rules set by national tax law for determining which facts give rise to a tax liability. These rules are not addressed in tax treaties and are therefore not affected by them. (Emphasis added.)

Furthermore, Paragraph 24 provides that Ait is the view of the wide majority that such rules, and the underlying principles, do not have to be confirmed in the text of the convention to be applicable.@ (Emphasis added.) 14

Paragraphs 23 and 24 of the 1992 and 1998 OECD Commentaries to Article 1 are instructive regarding the proper interaction of general anti-abuse rules and the United States - United Kingdom Income Tax Convention. The principles adopted by these OECD Commentaries, which reflect the views of the wide majority of OECD member countries, clearly indicate that domestic anti-abuse principles are applied independently of the United States - United Kingdom Income Tax Convention. Moreover, permitting continued application of domestic anti-abuse rules is consistent with prevention of fiscal evasion, one of the main purposes of tax conventions.

The case law and the Commentaries provide convincing evidence that the purpose of Article 7, Paragraph 3 of the United States - United Kingdom Income Tax Convention is completely unrelated to the I.R.C. ' 882(c)(2) timely filing requirement. Therefore, the I.R.C. ' 882(c)(2) timely filing requirement, as set forth in Treas. Reg. ' 1.882-4, continues to apply after the effective date of the Tax Convention. See S. REP. NO. 445, 100th Cong., 2d Sess. at 317 (1988). Moreover, the Aclear repugnancy@ that is required for a later legislative enactment to repeal an earlier one by implication is not present in the instant case because the two enactments do not address the same issues and are not irreconcilable. See Georgia v. Pennsylvania Railroad Co., 324 U.S. 439 (1945); Morton v. Mancari, 417 U.S. 535 (1974); Zenith Radio Corp. v. Matsushita Elec. Indus. Co., 494 F. Supp. 1263,1267 (E.D. Pa. 1980). Because there is no clearly expressed congressional intent that the provisions of the Business Profits Article of the United States - United Kingdom Income Tax Convention repeal the provisions of I.R.C. ' 882(c)(2) and its timely filing requirement, and because the two enactments are capable of co-existence, both enactments are required to be regarded as effective concurrently. Morton v. Mancari, 417 U.S. at 551.

Finally, had the Taxpayer complied with the minimal requirements of filing a protective return, as permitted by Treas. Reg. ' 1.882-4, the Taxpayer would have been permitted deductions and, accordingly, would have been taxed on the business profits determined by the arm's-length standard of Article VII (Business Profits). Treas. Reg. ' 1.882-4(a)(3)(iv) provides a foreign corporation with the option to timely file a protective return when it conducts limited activities within the United States which may not give rise to income that is effectively connected with a U.S. trade or business. The foreign corporation may follow this same procedure if it determines initially that it has no U.S. tax liability under the provisions of an applicable treaty. In the event the foreign corporation relies on the provision of an income tax treaty to reduce or eliminate the income subject to taxation, or to reduce the rate of tax, disclosure may be required pursuant to I.R.C. ' 6114. By filing a protective return within the time limits set forth under Treas. Reg. ' 1.882-4(a)(3)(i), the foreign corporation preserves its rights to allowable deductions and credits, and avoids any 15

potential disallowance of deductions and credits issues that may arise by virtue of I.R.C. ' 882(c). On the protective return, the foreign corporation need not report any amounts for gross income, deductions or credits and should simply attach a statement indicating that the return is being filed for protective purposes.

ISSUE 3:

The Taxpayer also argues that I.R.C. ' 884(c)(2), as interpreted by Treas. Reg.
' 1.882-4, violates the non-discrimination article of the United States -United Kingdom Income Tax Convention. Paragraph 2 of Article 24 (Non-discrimination) of the United States - United Kingdom Income Tax Convention provides in part:

The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.

As a threshold matter, it is clear that I.R.C. ' 882(c)(2) and the regulations thereunder, per se, do not violated the nondiscrimination articles of our income tax treaties.
Paragraph 5 of Article 24 (Non-discrimination) of the United States - United Kingdom Income Tax Convention provides in part:

Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first mentioned State in the same circumstances are or may be subjected.

The Treasury Department=s Technical Explanation to paragraph 2 of Article 24 in part provides:

Paragraph (2) provides that a permanent establishment which an enterprise of one Contracting State has in the other Contracting State will not be subject in that other Contracting State to less favourable taxation than an enterprise of that other Contracting State carrying on the same activities. (Emphasis added.)

Although Treas. Reg. ' 1.882-4 only applies to foreign corporations, and not to domestic corporations, that fact does not give rise to a violation of paragraph 2 of Article 24 of the United States - United Kingdom Income Tax Convention because the difference in treatment is based on the difference in enforcement problems of foreign corporations versus domestic corporations; it is much more difficult for the Service to detect a noncompliant foreign corporation than a noncompliant domestic corporation. 16

Treas. Reg. ' 1.882-4 is specifically directed at this difference, which creates a situation "pregnant with the possibilities of tax evasion" and places "a premium on tax evasion." Blenheim Co., Ltd v. Commissioner, 125 F.2d 906 (4th Cir. 1942), aff'g 42 B.T.A. 1248 (1940); Taylor Securities, Inc. v. Commissioner, 40 B.T.A. 696 (1938). I.R.C. ' 882(c)(2) was intended to offer strong incentives to foreign corporations to file U.S. income tax returns and, consequently, to reduce the opportunity for tax evasion. See Espinosa, 107 T.C. at 152.

As set forth in the preamble to Treas. Reg. ' 1.882-4, the timely filing requirement is justified because of the different administrative and compliance concerns that are present with respect to foreign corporations that are not present with domestic corporations. I.R.C. ' 882(c)(2) and Treas. Reg. ' 1.882-4 are specifically directed at the potential of tax evasion, created by the difficulty in identifying foreign corporations, as evidenced from the fact the protective return provisions of Treas. Reg. ' 1.882-4 (a)(3)(iv) only requires that the taxpayer identify itself to the Internal Revenue Service; no actual calculation of income, deductions or credits is required.

Treas. Reg. ' 1.882-4 is merely a procedural requirement, and differences in procedural requirements are permitted; it is merely taxing non-resident persons differently, for practical reasons. Further, Treas. Reg. ' 1.882-4 does not result in a different net tax result because as long as the foreign corporation complies with its administrative and procedural requirements, the net tax result for the foreign corporation will be the same as that of a U.S. corporation. Moreover, there is no Aclear and manifest@ intent on the part of Congress that the non-discrimination Article of the United States - United Kingdom Income Tax Convention override I.R.C. ' 882(c). Zenith Radio Corp. v. Matsushita Elec. Indus.
Co., 494 F. Supp. 1263, 1266 (E.D. Pa. 1980).

The Commentaries to paragraph 4 of Article 24 of the 1977 OECD Model Convention provide that:

As regards the first sentence [of paragraph 4 of Article 24], experience has shown that it was difficult to define clearly and completely the substance of the principle of equal treatment and this has led to wide differences of opinion with regard to the many implications of this principle. The main reason for difficulty seems to reside in the actual nature of the permanent establishment, which is not a separate legal entity but only a part of an enterprise that has its head office in another State. The situation of the permanent establishment is different from that of a domestic enterprise, which constitutes a single entity all of whose activities, with their fiscal implications, can be fully brought within the purview of the State where it has its head office.... (Emphasis added.) 17

Similarly, the Treasury Department=s Technical Explanation to the 1996 U.S. Model Income Tax Convention includes the following with respect to Article 24 (Non- discrimination):

The fact that a U.S. permanent establishment of an enterprise of the other Contracting State is subject to U.S. tax only on income that is attributable to the permanent establishment, while a U.S. corporation engaged in the same activities is taxable on its worldwide income is not, in itself, a sufficient difference to deny national treatment to the permanent establishment. There are cases, however, where the two enterprises would not be similarly situated and differences in treatment may be warranted. For instance, it would not be a violation of the nondiscrimination protection of paragraph 2 [which corresponds to paragraph 2 of Article 24 of the United States - United Kingdom Income Tax Convention] to require the foreign enterprise to provide information in a reasonable manner that may be different from the information requirements imposed on a resident enterprise, because the information may not be as readily available to the Internal Revenue Service from a foreign as from a domestic enterprise. Similarly, it would not be a violation of paragraph 2 to impose penalties on persons who fail to comply with such a requirement (see, e.g., section 874 and 882(c)(2)).

We believe these Commentaries highlight the inadvisability of interpreting the non-discrimination articles in our income tax treaties in a manner that requires absolute consistency in treatment between permanent establishments and resident enterprises. We believe that, in general, domestic laws which impose particular requirements and penalties on foreign corporations do not violate the non- discrimination articles of our income tax treaties if those laws are specifically designed to address reasonably the unique circumstances of foreign corporations doing business in the United States.

Notwithstanding this threshold conclusion, we note that the Non-discrimination Article of the United States - United Kingdom Income Tax Convention requires careful consideration of all the facts and circumstances surrounding the application of the provisions of I.R.C. ' 882(c)(2) and the regulations thereunder in a particular case. As indicated above, the Treasury Department=s Technical Explanation to the 1996 U.S. Model Income Tax Convention provides the following:
it would not be a violation of the nondiscrimination protection of paragraph 2 [which corresponds to paragraph 2 of the United States - United Kingdom Income Tax Convention] to require the foreign enterprise to provide information in a reasonable manner that may be different from the information requirements imposed on a resident enterprise, because information may not be as readily available to the Internal Revenue Service from a foreign as from a domestic enterprise. (Emphasis added.)

Likewise, the Senate Finance Committee Report to I.R.C. ' 7852(d)(1) provides: 18

the committee does not believe that any nondiscrimination provision of any U.S. treaty bars the application of reasonable collection mechanisms designed to ensure the collection of tax, the imposition of which is permitted by the treaty. (Emphasis added.)

Thus, we believe that an evaluation under a non-discrimination article of an income tax treaty of the potential application of a particular domestic requirement or penalty should take into account whether the results of that requirement or penalty are Areasonable.@ That is, a domestic requirement or penalty targeted specifically to nonresidents, albeit generally well-designed to accomplish a reasonable goal, may be found to violate the non- discrimination article of an income tax treaty when applied in a particular case if the result places the nonresident in a less favorable position vis-a-vis a similarly situated resident in an unreasonable manner.

Further, as described above, courts have generally given great weight to the government=s interpretation of a treaty if it represents a long-standing construction or an Aactual, reasonably harmonious practice@ adopted by the contracting states. Kolovrat v. Oregon, 366 U.S. 187, 194 (1961); Restatement (3rd) of Foreign Relations Law '326(2) 1987; TWA v. Franklin Mint, 466 U.S. 243, 259 (1984); United States v. A.L. Burbank, 525 F.2d 9, 15-16 (2d Cir. 1975). Therefore, the extent to which a treaty interpretation harmonizes with the views of our treaty partners can be important to the sustention of that interpretation. Accordingly, the determination of whether or not the Non-discrimination Article of the 1984 Treaty can be invoked to challenge the application of I.R.C. ' 882(c)(2) to the facts of a particular case will depend in part upon the United Kingdom=s views on the proper role for administrative requirements concerning permanent establishments, which views, in turn, may depend in part on the reasonableness of the results flowing from the application of I.R.C. ' 882(c)(2) in individual cases.

In summary, we believe that I.R.C. ' 882(c)(2), as interpreted by Treas. Reg.
' 1.882-4, per se, does not violate the Non-discrimination Article of the United States - United Kingdom Income Tax Convention. We believe, however, that the Non- discrimination Article calls for careful consideration of all the facts and circumstances surrounding the application of the provisions of I.R.C. ' 882(c)(2) in a particular case. This consideration should include an evaluation of whether or not the results of applying I.R.C. ' 882(c)(2) are reasonable and whether or not the United Kingdom would view those results to be consistent with its understanding of the role of reasonable administrative procedures applicable to permanent establishments. We believe the U.S. Competent Authority would be in the best position to evaluate whether the result in this particular case is a reasonable one, taking into account its understanding of the views of our treaty partners, on the proper role for administrative requirements and penalties specifically targeted to permanent establishments. 19

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS:

Although not raised by the taxpayer, your memorandum dated June 22, 1999, raises the issue of whether the Taxpayer can establish that it is entitled to relief under Treas. Reg. ' 1.882-4(a)(3)(ii). That subsection provides:

The filing deadlines ... may be waived by the District Director or Assistant Commissioner (International), in rare and unusual circumstances if good cause for such waiver, based on the facts and circumstances, is established by the foreign corporation.

There are no legal precedents that define the required threshold for establishing the Arare and unusual circumstances@ in which Agood cause ... based on the facts and circumstances@ may be established under Treas. Reg. ' 1.882-4(a)(3)(ii). However, the language Arare and unusual@ suggests that the facts and circumstances presented must involve an infrequent or uncommon event that resulted in the Taxpayer=s failure to file. Moreover, the regulations should not be broadly interpreted so as to defeat the legislative purpose of disallowing deductions unless a return is filed in a timely manner. If the waiver provision is broadly interpreted, or freely granted, the effect would be to nullify Treasury=s sole purpose for issuing deadlines with respect to foreign corporate returns.

We note that because I.R.C. ' 882(c)(2), and the related regulations, operate like a penalty provision by disallowing deductions and credits to a foreign corporation when it fails to file a required return, requesting a waiver of the filing deadlines is analogous to requesting an exemption of the failure to file penalty under I.R.C. ' 6651(a)(1). That is, under either of these two situations, the taxpayer is seeking relief from the operation of a penalty provision. However, these two provisions impose different standards of proof before a taxpayer may be relieved from the consequences of the penalty. A foreign corporation requesting a waiver of the filing deadlines must show Agood cause@ based on the facts and circumstances, whereas a taxpayer seeking relief from I.R.C. ' 6651(a)(1) has to establish Areasonable cause.@ We believe the Agood cause@ threshold involves a higher standard of proof than what is required under Areasonable cause.@

The good cause standard is a factual determination which we feel your office and the examination team is more well equipped to make. We concur with your views, however, that Taxpayer=s explanation, citing the operational problems it allegedly encountered after acquiring Corporation A, is insufficient to show the required "rare and unusual circumstances" to establish "good cause" for a waiver. The Taxpayer was aware 20

of the filing requirement and possessed sufficient expertise and resources to meet the filing deadlines, but failed to devote the resources necessary to meet its filing obligations. We concur with your opinion that this is not an exceptional circumstance requiring relief under Treas. Reg. ' 1.882-4(a)(3)(ii).

If you have any further questions, please call 622-3880.

__________
W. EDWARD WILLIAMS
Senior Technical Reviewer, Branch 1
Associate Chief Counsel (International)