Sunoco, Inc. and Subsidiaries v. Commissioner

118 T.C. No. 11

• Court: United States Tax Court
• Decided: March 15, 2002
• Docket: 19631-97
• Status: Unknown

Opinion

118 T.C. No. 11

UNITED STATES TAX COURT

SUNOCO, INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19631-97. Filed March 15, 2002.

P claimed foreign tax credits under sec. 901(a), I.R.C., on its consolidated returns for 1982, 1983, 1984, and 1986. In these proceedings, P seeks to change the method of computing the overall limitation on the credit imposed by sec. 904(a), I.R.C. Specifically, P seeks to change the manner in which it allocates and apportions interest expenses for purposes of computing taxable income from sources without the United States, the numerator of the limiting fraction. P claims that it is entitled to offset interest income against interest expenses before it allocates and apportions net interest expenses under sec. 1.861-8(e)(2), Income Tax Regs. Held: Sec. 1.861-8(e)(2), Income Tax Regs., does not permit P to allocate and apportion net interest expenses. The Tax Court's decision in Bowater, Inc., & Subs. v. Commissioner, 101 T.C. 207 (1993), revd. 108 F.3d 12 (2d Cir. 1997), which holds the opposite, is hereby overruled. - 2 -

Marjorie A. Burnett, Thomas D. Johnston, Robert L.

Moore II, Michael J. McGoldrick, and Nancy M. Seweryn,

for petitioner.

John A. Guarnieri, Richard H. Gannon, and Keith L.

Gorman, for respondent.

OPINION

WHALEN, Judge: Respondent determined the following

deficiencies in petitioner's Federal income tax:

Year Deficiency

1979 $10,563,157 1981 5,163,449 1983 35,916,359

Petitioner disputes the above deficiencies and further

claims to have overpaid income taxes for 1979, 1981, and

1983 by at least $25,082,591, $6,881,055, and $14,137,211,

respectively.

After concessions, there are three issues for decision

in this case. Each issue will be the subject of a separate

opinion. The issue that is the subject of this opinion

arises in the context of computing the overall limit

imposed by section 904(a) on the foreign tax credits

claimed by petitioner under section 901(a) for taxable

years 1982, 1983, 1984, and 1986, referred to herein as

the years in issue. In this opinion, all section -3-

references are to the Internal Revenue Code as in effect

during the years in issue, unless stated otherwise.

This issue involves the computation of income from

sources without the United States, the numerator of the

limiting fraction under section 904(a). Specifically,

in allocating and apportioning interest expenses for

purposes of computing taxable income from sources without

the United States for the years in issue, the question is

whether section 1.861-8(e)(2), Income Tax Regs.,

contemplates that the aggregate interest expense

incurred by each member of petitioner's affiliated group

of corporations for the taxable year can first be offset

by that member's interest income. Stated more simply, the

issue is whether netting of interest expense and interest

income is permitted by section 1.861-8(e)(2), Income Tax

Regs.

As a preliminary matter, we must decide an evidentiary

objection raised by respondent. Respondent filed a motion

in limine to exclude the testimony of an economist, Dr. J.

Gregory Ballentine, who was called by petitioner as an

expert witness. Respondent argues that Dr. Ballentine's

testimony should be excluded because it represents

"irrelevant and immaterial legal conclusions and opinions

and does not assist the Court." Respondent also contends - 4 -

that Dr. Ballentine's testimony should be excluded because

it amounts to impermissible advocacy.

Respondent also proffered the testimony of an expert

witness but did so only to preserve the Commissioner's

right to offer such testimony if the testimony of

petitioner's expert were admitted into evidence. At trial,

the Court permitted both experts to testify and reserved

ruling on respondent's motion in limine.

Petitioner offers the testimony of Dr. Ballentine to

"assist the Court in interpreting the economic terms in

section 1.861-8(e)(2)", Income Tax Regs. According to his

report, Dr. Ballentine reached two overall conclusions:

(1) "Netting interest income against interest expense

implements the economic concept of the fungibility of money

as it relates to sources of funds"; (2) "interest netting

achieves a tax neutrality between borrowing and reducing

cash balances as sources of funds." Petitioner argues

the same two principles in the posttrial briefs filed on

its behalf. Dr. Ballentine's report states that he was

retained "to provide an economic evaluation of netting

interest income against interest expense for purposes of

the tax rules that apportion interest expense between

domestic and foreign source income." - 5 -

Rule 702 of the Federal Rules of Evidence, which

governs the admissibility of expert testimony, provides:

If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, train- ing, or education, may testify thereto in the form of an opinion or otherwise.* * *

Thus, expert testimony is admissible under rule 702 if

it assists the Court to understand the evidence or to

determine a fact in issue.

The parties agree that the subject issue, involving

the interpretation of section 1.861-8(e)(2), Income Tax

Regs., is a question of law and that there are no facts

in dispute. Thus, the question we must answer is whether

Dr. Ballentine's testimony aids the Court in understanding

the evidence. Dr. Ballentine's testimony provides economic

examples and policy reasons as to why the appropriate

measure of interest expense is net interest expense.

Petitioner's brief reiterates these same concepts and

includes the same examples.

We find that Dr. Ballentine's report and testimony

merely advocate petitioner's position and do not aid the

Court "to understand the evidence or to determine a fact - 6 -

in issue". Fed. R. Evid. 702. Expert testimony is not

admissible for such purposes. An expert who is merely an

advocate of a party's position does not assist the Court

in understanding the issue. See Hosp. Corp. of Am.

v. Commissioner, 109 T.C. 21 (1997); Alumax, Inc. v.

Commissioner, 109 T.C. 133 (1997), affd. 165 F.3d 822

(11th Cir. 1999); Snap-Drape, Inc. v. Commissioner, 105

T.C. 16, 20 (1995), affd. 98 F.3d 194 (5th Cir. 1996);

Laureys v. Commissioner, 92 T.C. 101, 129 (1989);

Robertson v. Commissioner, T.C. Memo. 1999-130, affd.

without published opinion 87 AFTR2d 2001-1274, 2001-1 USTC

par. 50,276 (9th Cir. 2001); see also Estate of Halas v.

Commissioner, 94 T.C. 570, 577 (1990) ("In the context of

valuation cases, we have observed that experts may lose

their usefulness and credibility when they merely become

advocates for one side.").

We conclude that Dr. Ballentine's testimony does

not assist the Court in understanding the legal question

issue and is not admissible. Accordingly, we shall grant

respondent's motion in limine.

Most of the facts relating to the issue which is the

subject of this opinion were stipulated by the parties.

The stipulated facts and accompanying exhibits are so found

and are hereby incorporated in this opinion. - 7 -

Petitioner was incorporated under the laws of the

Commonwealth of Pennsylvania. At the time the instant

petition was filed on its behalf, petitioner's principal

place of business and mailing address was in Philadelphia,

Pennsylvania. During each of the tax years in issue,

petitioner was the common parent of an affiliated group of

corporations, as defined in section 1504(a), and it filed a

consolidated Federal income tax return on behalf of itself

and the other members of the affiliated group as permitted

by section 1501.

At all times material to this case, petitioner and

the other members of its affiliated group engaged in the

business of acquiring and developing oil, gas, and other

energy properties, of refining or otherwise preparing the

natural resources produced from the properties for sale

to customers, and of marketing and transporting those

products to customers both in the United States and abroad.

During the years in issue, petitioner and its affiliated

corporations earned income from various sources, domestic

and foreign, including income from interest, dividends, the

production of oil and gas and other hydrocarbons, and the

sale of products derived from the production of

hydrocarbons. - 8 -

Petitioner chose to use the foreign tax credit under

section 901(a) in computing the tax liability of its

affiliated group of corporations for consolidated return

years 1982, 1983, 1984, and 1986. In computing the overall

limitation on the credit under section 904(a), petitioner

allocated and apportioned a portion of the interest expense

of each member of the affiliated group to sources without

the United States for purposes of computing the numerator

of the limiting fraction under section 904(a); i.e.,

taxable income from sources without the United States.

The following schedule sets forth the deduction for

interest claimed by each member of petitioner's affiliated

group for each of the years in issue, the portion of such

amount that was allocated and apportioned to sources

without the United States for each year, and the ratio of

the latter to the former: - 9 - Apportioned Interest to foreign Ratio 1982 expense source income percent

650 Leasing Co. $682,931 $235,504 37.12 Sun Leasing Co. 4,729,086 2,729,628 57.72 666 Leasing Co. 4,072,539 2,138,083 52.50 670 Leasing Co. 1,830,136 853,210 46.62 673 Leasing Co. 1,627,381 727,928 44.73 675 Leasing Co. 1,983,276 1,002,744 50.56 652 Leasing Co. 794,330 356,448 44.87 Kee Leasing Co. 581,235 403,610 69.44 653 Leasing Co. 814,727 398,972 48.97 667 Leasing Co. 3,286,585 1,709,024 52.00 Millcreek Leasing Co. 830,407 202,492 24.38 DeSun Shipping 47,658 33,697 70.71 Eastern Sun Shipping 37,115 24,183 65.16 NY Sun Shipping 9,970,340 8,851,391 88.78 NJ Sun Shipping 143,340 116,170 81.05 PA Shipping 46,423 29,294 63.10 Phil Sun Shipping 10,809,958 3,214,297 29.74 Western Sun Shipping 50,003 31,980 63.96 Sun Transport, Inc. 3,650,045 1,465,486 40.15 Sun Note Co. 31,066,253 31,066,253 100.00 North Sea Oil Co. 65,897 65,897 100.00 Totem Ocean Trailer 46,949 29,813 63.50

77,166,614 55,704,104

Apportioned Interest to foreign Ratio 1983 expense source income percent

650 Leasing Co. $612,220 $357,904 58.46 Sun Leasing Co. 4,736,241 2,808,118 59.29 666 Leasing Co. 4,084,197 2,580,396 63.18 670 Leasing Co. 1,756,214 973,645 55.44 652 Leasing Co. 714,282 312,641 43.77 Kee Leasing Co. 504,412 357,058 70.79 653 Leasing Co. 736,315 375,962 51.06 667 Leasing Co. 3,160,356 2,019,783 63.91 Millcreek Leasing Co. 742,214 365,707 49.27 NY Sun Shipping 9,849,306 8,573,395 87.05 NJ Sun Shipping 208,102 129,266 62.12 Phil Sun Shipping 10,688,995 3,437,299 32.16 Texas Sun Shipping 33,963 12,819 37.74 Tropic Sun Shipping 474,700 272,684 57.44 Sun Transport, Inc. 2,644,781 926,810 35.04 Heleasco Fifteen 1,444,639 1,297,009 89.78 Sun Note Co. 25,667,812 25,634,424 99.87

68,058,749 50,434,920 - 10 - Apportioned Interest to foreign Ratio 1984 expense source income percent

Kee Leasing Co. $408,197 $154,339 37.81 666 Leasing Co. 4,083,327 1,964,080 48.10 670 Leasing Co. 1,669,360 610,485 36.57 650 Leasing Co. 536,038 270,003 50.37 652 Leasing Co. 613,066 176,024 28.71 653 Leasing Co. 636,635 118,974 18.69 667 Leasing Co. 3,018,359 885,134 29.33 Sun Leasing Co. 4,689,864 2,059,788 43.92 NY Sun Shipping 9,712,823 9,165,743 94.37 Phil Sun Shipping 10,551,646 4,687,164 44.43 Tropic Sun Shipping 644,883 313,703 48.64 Sun Transport, Inc. 3,091,754 985,633 31.88 1 Sun Oil Trading Co. 627,633 32,260 5.14 Sun Note Co. 25,854,099 25,693,399 99.38 North Sea Sun Oil Co. 7,681,288 7,541,569 98.18

73,818,972 54,658,298 1 One of petitioner's exhibits lists this amount as $2,114,469. See p. 17, infra.

Apportioned Interest to foreign Ratio 1986 expense source income percent

Kee Leasing Co. $213,410 $27,604 12.93 666 Leasing Co. 3,907,731 1,750,664 44.80 670 Leasing Co. 1,468,580 621,944 42.35 650 Leasing Co. 404,732 189,415 46.80 Sun Leasing Co. 4,532,004 1,960,092 43.25 Millcreek Leasing Co. 435,448 102,064 23.44 Tropic Sun Shipping 644,829 242,814 37.66 Sun Transport, Inc. 2,356,829 650,044 27.58 Sunoco Overseas, Inc. 211.438 211,438 100.00 Sun Refining & Mktg. Co. 44,588,973 4,598,484 10.31 Sun Oil Trading Co. 549,406 8,918 1.62 Sun Co., Inc. 157,687,537 5,097,677 3.23 Sun Oil Intl. 7,190,703 2,487,983 34.60 North Sea Sun Oil Co. 28,050,064 27,208,562 97.00 Claymont Investment Co. 217,180,793 47,426 0.02

469,422,477 45,205,129

The parties have stipulated that "in most cases"

the interest expense of each member of petitioner's

affiliated group of corporations was apportioned "in

general accordance with the optional gross income method

[sic] of apportionment described in Treas. Reg. §1.861-

8(e)(2)(vi)." The stipulation does not state which of the

optional gross income methods described by sec. 1.861-

8(e)(2)(vi), Income Tax Regs., was used in the case of any - 11 -

member of the group. In any event, the following schedule

shows the gross income of each member of petitioner's

affiliated group of corporations for each of the subject

years, that member's gross income from sources without the

United States for each year, and the ratio of the latter

to the former: Foreign Ratio 1982 Gross income gross income percent

650 Leasing Co. $3,288,110 $1,221,496 37.15 Sun Leasing Co. 6,872,415 3,966,133 57.71 666 Leasing Co. 6,401,918 3,372,797 52.68 670 Leasing Co. 4,733,818 2,214,708 46.78 673 Leasing Co. 4,308,780 1,924,955 44.68 675 Leasing Co. 3,987,511 2,016,544 50.57 652 Leasing Co. 3,183,942 1,420,014 44.60 Kee Leasing Co. 1,720,403 1,194,921 69.46 653 Leasing Co. 3,209,671 1,576,737 49.12 667 Leasing Co. 7,577,559 3,950,760 52.14 Millcreek Leasing Co. 6,775,203 1,652,111 24.38 DeSun Shipping 1,868,480 1,321,135 70.71 Eastern Sun Shipping 340,725 222,010 65.16 NY Sun Shipping 8,302,978 6,755,590 81.36 NJ Sun Shipping -814,965 575,083 -70.57 PA Shipping 3,912,021 2,468,565 63.10 Phil Sun Shipping 6,602,489 1,963,223 29.73 Western Sun Shipping 2,574,519 1,646,584 63.96 Sun Transport, Inc. 95,328,918 38,274,373 40.15 Sun Note Co. 43,260,421 41,406,722 95.72 North Sea Oil Co. 42,518,569 42,518,569 100.00 Totem Ocean Trailer 92,031,992 57,380,743 62.35

347,985,477 219,043,773 - 12 - Foreign Ratio 1983 Gross income gross income percent

650 Leasing Co. $2,593,100 $1,508,054 58.16 Sun Leasing Co. 6,973,146 4,151,644 59.54 666 Leasing Co. 8,943,399 5,644,013 63.11 670 Leasing Co. 4,132,347 2,304,872 55.78 652 Leasing Co. 2,523,829 1,104,364 43.76 Kee Leasing Co. 2,012,673 1,424,195 70.76 653 Leasing Co. 2,552,479 1,306,385 51.18 667 Leasing Co. 6,427,811 4,098,914 63.77 Millcreek Leasing Co. 8,220,982 4,050,674 49.27 NY Sun Shipping 7,917,134 6,891,523 87.05 NJ Sun Shipping 3,008,541 1,868,808 62.12 Phil Sun Shipping 6,930,169 2,228,559 32.16 Texas Sun Shipping 1,392,393 525,539 37.74 Tropic Sun Shipping 3,047,355 1,750,507 57.44 Sun Transport, Inc. 85,157,516 29,842,158 35.04 Heleasco Fifteen 2,415,666 2,168,805 89.78 Sun Note Co. 44,530,627 42,711,487 95.91

198,779,167 113,580,501

Foreign Ratio 1984 Gross income gross income percent

Kee Leasing Co. $2,014,039 $761,330 37.80 666 Leasing Co. 8,573,805 4,137,017 48.25 670 Leasing Co. 4,362,352 1,586,209 36.36 650 Leasing Co. 2,657,644 1,339,771 50.41 652 Leasing Co. 2,557,004 731,691 28.62 653 Leasing Co. 2,592,171 483,157 18.64 667 Leasing Co. 6,563,855 1,936,224 20.50 Sun Leasing Co. 7,404,599 3,269,459 44.15 NY Sun Shipping 9,454,505 8,921,975 94.37 Phil Sun Shipping 5,129,727 2,278,684 44.42 Tropic Sun Shipping 4,004,764 1,948,117 48.64 Sun Transport, Inc. 73,123,906 23,311,476 31.88 Sun Oil Trading Co. 20,037,455 710,113 3.54 Sun Note Co. 40,344,826 40,094,056 99.38 North Sea Sun Oil Co. 23,924,318 17,319,539 72.39

212,744,970 108,828,818

Foreign Ratio 1986 Gross income gross income Percent

Kee Leasing Co. $2,013,346 $260,455 12.94 666 Leasing Co. 7,082,756 3,172,987 44.80 670 Leasing Co. 3,533,401 1,496,424 42.35 650 Leasing Co. 2,038,955 954,294 46.80 Sun Leasing Co. 6,194,365 2,679,882 43.26 Millcreek Leasing Co. 305,752 -83,676 27.37 Tropic Sun Shipping 3,986,919 1,501,298 37.66 Sun Transport, Inc. 79,520,790 21,932,881 27.58 Sunoco Overseas, Inc. -108,199 290,314 100.00 Sun Refining & Mktg. Co. 672,597,605 1,095,517 0.16 Sun Oil Trading Co. 13,481,454 4,673,000 34.66 Sun Co., Inc. 760,884,991 23,864,572 3.14 Sun Oil Intl. 10,593,916 6,769,393 34.55 North Sea Sun Oil Co. 36,565,327 36,394.917 99.53 Claymont Investment Co. 513,112,873 111,203 00.02

2,120,804,251 105,113,461 - 13 -

In allocating and apportioning each member's interest

expense to sources without the United States under one

of the optional gross income methods described by section

1.861-8(e)(2)(vi), Income Tax Regs., petitioner started

with the gross amount of each member's interest expense

for the taxable year and did not offset that amount by

the interest income earned by that member during the year.

As mentioned above, petitioner chose to use the

foreign tax credit under section 901(a) in computing the

tax liability of its affiliated group of corporations for

consolidated return years 1982, 1983, 1984, and 1986. As

to each of those years, the amount of foreign taxes for

which a taxpayer could claim credit was subject to the

overall limitation of section 904. Under that limitation,

the amount of foreign tax credit could not exceed the

tentative U.S. tax for the year (i.e., the U.S. tax before

application of the foreign tax credit) multiplied by a

fraction, the numerator of which is the taxable income from

sources without the United States and the denominator of

which is the entire taxable income. Sec. 904(a).

Generally, in the case of an affiliated group of

corporations, the foreign tax credit is determined on a

consolidated basis. Sec. 1.1502-4(c), Income Tax Regs.

In computing the overall limitation under section 904(a) - 14 -

for an affiliated group, the numerator of the limiting

fraction is an amount equal to the total of the separate

taxable incomes of the members of the group from sources

without the United States, with certain adjustments that

are not material to this case. See sec. 1.1502-4(d)(1),

Income Tax Regs. The denominator of the limiting fraction

under section 904(a) is the consolidated taxable income of

the group computed in accordance with section 1.1502-11,

Income Tax Regs. Sec. 1.1502-4(d)(2), Income Tax Regs.

Thus, for each of the subject consolidated return years,

petitioner was required to compute the "taxable income from

sources without the United States" of each member of its

affiliated group of corporations. Sec. 904(a). The total

of those amounts is the numerator of the limiting fraction

under section 904(a).

In these proceedings, petitioner seeks to make two

changes in the method used to allocate and apportion

interest expenses for purposes of computing each member's

First, petitioner seeks to apportion the interest expenses

of each member of its affiliated group using the asset

method described in section 1.861-8(e)(2)(v), Income Tax

Regs., for tax years 1982, 1983, and 1984, and using one

of the optional gross income methods described by section - 15 -

1.861-8(e)(2)(vi), Income Tax Regs., for tax year 1986.

As mentioned above, petitioner had used one of the

optional gross income methods described by section 1.861-

8(e)(2)(vi), Income Tax Regs., in apportioning interest

expenses on each of the subject returns. Respondent

concedes that petitioner is entitled to make this change,

as long as all members joining the 1986 return use one of

the optional gross income methods described by section

1.861-8(e)(2)(vi), Income Tax Regs.

The second change sought by petitioner, the change

at the heart of the instant controversy, involves

petitioner's assertion that each member's interest expense

to be allocated and apportioned under section 1.861-

8(e)(2), Income Tax Regs., for purposes of computing the

overall limitation under section 904(a), is "net interest

expense", i.e., interest expense for the year less interest

income but not less than zero, rather than gross interest

expense. Respondent asserts that this change is improper.

To quantify petitioner's position, the following

schedule sets forth the interest expense incurred by each

member of petitioner's affiliated group of corporations,

the interest income earned by that member, and the net

interest expense of that member; i.e., interest expense

less interest income but not less than zero: - 16 - Interest Interest Net interest 1982 expense income expense

650 Leasing Co. $682,931 $1,379,522 -0- Sun Leasing Co. 4,729,086 1,512,776 $3,216,310 666 Leasing Co. 4,072,539 1,904,855 2,167,684 670 Leasing Co. 1,830,136 1,740,970 89,166 673 Leasing Co. 1,627,381 1,253,296 374,085 675 Leasing Co. 1,983,276 836,661 1,146,615 652 Leasing Co. 794,330 1,285,273 -0- Kee Leasing Co. 581,235 13,373 567,862 653 Leasing Co. 814,727 1,309,988 -0- 667 Leasing Co. 3,286,585 2,639,109 647,476 Millcreek Leasing Co. 830,407 1,357,133 -0- DeSun Shipping 47,658 135,470 -0- Eastern Sun Shipping 37,115 82,228 -0- NY Sun Shipping 9,970,340 854,008 9,116,332 NJ Sun Shipping 143,340 16,205 127,135 PA Shipping 46,423 133,771 -0- Phil Sun Shipping 10,809,958 448,677 10,361,281 Western Sun Shipping 50,003 66,869 -0- Sun Transport Inc. 3,650,045 99,840 3,550,205 Sun Note Co. 31,066,253 32,754,418 -0- North Sea Oil Co. 65,897 1,176,482 -0- Totem Ocean Trailer 46,949 1,668,617 -0-

77,166,614 52,669,541 31,364,151

Interest Interest Net Interest 1983 expense income expense

650 Leasing Co. $612,220 $684,172 -0- Sun Leasing Co. 4,736,241 1,581,401 $3,154,840 666 Leasing Co. 4,084,197 1,707,485 2,376,712 670 Leasing Co. 1,756,214 1,139,007 617,207 652 Leasing Co. 714,282 631,498 82,784 Kee Leasing Co. 504,412 6,765 497,647 653 Leasing Co. 736,315 658,732 77,583 667 Leasing Co. 3,160,356 1,489,361 1,670,995 MillCreek Leasing Co. 742,214 2,132,982 -0- NY Sun Shipping 9,849,306 727,159 9,122,147 NJ Sun Shipping 208,102 449,738 -0- Philadelphia Sun Shipping 10,688,995 855,141 9,833,854 Texas Sun Shipping 33,963 704,193 -0- Tropic Sun Shipping 474,700 569,955 -0- Sun Transport, Inc. 2,644,781 980,197 1,664,584 Heleasco Fifteen 1,444,639 246,861 1,197,778 Sun Note Co. 25,667,812 37,161,016 -0-

68,058,749 51,725,663 30,296,131 - 17 - Interest Interest Net interest 1984 expense income expense

Kee Leasing Co. $408,197 $10,538 $397,659 666 Leasing Co. 4,083,327 2,209,163 1,874,164 670 Leasing Co. 1,669,360 1,369,504 299,856 650 Leasing Co. 536,038 715,947 -0- 652 Leasing Co. 613,066 671,202 -0- 653 Leasing Co. 636,635 704,840 -0- 667 Leasing Co. 3,018,359 1,611,875 1,406,484 Sun Leasing Co. 4,689,864 2,044,830 2,645,034 NY Sun Shipping 9,712,823 532,530 9,180,293 Phil Sun Shipping 10,551,646 676,120 9,875,526 Tropic Sun Shipping 644,883 1,040,764 -0- Sun Transport, Inc. 3,091,754 35,223 3,056,531 1 Sun Oil Trading Co. 2,114,469 16,303,956 -0- Sun Note Co. 25,854,099 33,533,894 -0- North Sea Oil Co. 7,681,288 2,196,279 5,485,009

75,305,808 63,656,665 34,220,556 1 See p.10, supra.

Interest Interest Net interest 1986 expense income expense

Kee Leasing Co. $213,410 $9,844 $203,566 666 Leasing Co. 3,907,731 736,783 3,170,948 670 Leasing Co. 1,468,580 540,553 928,027 650 Leasing Co. 404,732 130,367 274,365 Sun Leasing Co. 4,532,004 834,601 3,697,403 Millcreek Leasing Co. 435,448 662,752 -0- Tropic Sun Shipping 644,829 1,148,919 -0- Sun Transport, Inc. 2,356,829 646,275 1,710,554 Sunoco Overseas, Inc. 211,438 189,663 21,775 Sun Refining & Mkt., Inc. 44,588,973 23,675,379 20,913,594 Sun Oil Trading Co. 549,406 317,610 231,796 Sun Co., Inc. 157,687,537 937,176 156,750,361 Sun Oil Int. 7,190,703 12,824,523 -0- North Sea Oil Co. 28,050,064 1,784,106 26,265,958 Claymont Investment Co. 217,180,793 505,319,941 -0-

469,422,477 549,758,492 214,168,347

Petitioner argues that it is entitled to use the amount in

column three of the above schedule, i.e., the net interest

expense of each member of its affiliated group, as the

starting point for allocating and apportioning that

member's interest expense under section 1.861-8(e)(2),

Income Tax Regs.

The parties have stipulated the amount of each

member's interest expense to be allocated and apportioned

to sources without the United States depending upon whether - 18 -

netting is or is not permitted. These stipulations are

summarized in the appendix to this Opinion.

In the appendix, each member's interest expense for

1982, 1983, and 1984 is apportioned to sources without the

United States in accordance with the asset method described

by section 1.861-8(e)(2)(v), Income Tax Regs. The parties

have stipulated the ratio of each member's assets which

relates to activities and properties that generated foreign

source income during each year. See generally sec. 1.861-

8(e)(2)(v), Income Tax Regs. Using that asset ratio, the

amount of a member's interest expense to be apportioned to

sources without the United States is computed, if netting

is not permitted, by multiplying the ratio and the member's

gross interest expense, or, if netting is permitted, by

multiplying the ratio and the member's net interest

expense.

1986 is apportioned to sources without the United States

in accordance with one of the optional gross income methods

described by section 1.861-8(e)(2)(vi), Income Tax Regs.

Generally, under that provision, assuming certain condi-

tions are met, the deduction for interest is apportioned to

sources within or without the United States ratably on the

basis of a taxpayer's gross income. See id. - 19 -

As shown in the appendix, the parties have stipulated

two sets of gross income ratios for 1986, one set to be

used assuming that netting is not permitted and the other

set to be used assuming that netting is permitted. The

amount of a member's interest expense to be apportioned to

is not permitted, by multiplying the first gross income

ratio and the member's gross interest expense, or, if

netting is permitted, by multiplying the second ratio

and the member's net interest expense. The appendix has

two schedules for 1986, one schedule summarizing the

apportionment of gross interest (i.e., no netting) and

one summarizing the apportionment of net interest (i.e.,

netting).

It appears that in computing the second set of gross

income ratios for 1986, the ratios to be used if netting

is permitted, the parties have adjusted the gross income of

each member by subtracting therefrom the amount of interest

income that is offset by interest expense. For example, in

the case of Kee Leasing Co., the first income ratio of

12.94 percent, the ratio to be used in apportioning

interest if netting is not permitted, was computed by

dividing the company's gross income from sources without

the United States, $260,455, by the company's gross income, - 20 -

$2,013,345. On the other hand, the second income ratio of

13 percent, the ratio to be used in apportioning interest

if netting is permitted, was computed after the amount of

netted interest income, $9,844, was subtracted from the

company's gross income, the denominator of the fraction.

Thus, the second ratio of 13 percent was computed by

dividing $260,455, the company's gross income from sources

without the United States, by $2,003,501, the company's

total gross income less the amount of netted interest

($2,013,345 minus $9,844).

Similar adjustments were made to the gross income of

each of the other 14 members of petitioner's affiliated

group for purposes of computing the second gross income

ratio; i.e., the ratio to be used in computing the interest

expense to be apportioned to sources without the United

States, assuming that netting is permitted.

Furthermore, in the case of one of the 15 members of

petitioner's affiliated group of corporations, North Sea

Sun Oil Co., a similar adjustment was made to the numerator

of the fraction that constitutes the gross income ratio.

That is, the interest income earned by that company during

1986, $1,784,106, was subtracted from the company's foreign

source gross income, $36,394,917, to arrive at $34,610,811,

the numerator of the fraction. That amount was divided - 21 -

by the excess of the company's total gross income,

$36,565,327, over its interest income, $1,784,106, or

$34,781,221, to arrive at the gross income ratio of 99.51

percent.

Thus, in computing the second gross income ratio for

North Sea Sun Oil Co. under section 1.861-8(e)(2)(vi),

Income Tax Regs., the ratio to be used if netting is

permitted, the interest income earned by North Sea Sun Oil

Co. during 1986 was subtracted from both the numerator and

the denominator of the fraction. The interest income

earned during 1986 by each of the other 14 members of

plaintiff's affiliated group was subtracted only from the

denominator of the fraction in computing the second gross

income ratio for each of those companies. We infer from

this that the interest income earned by North Sea Sun Oil

Co. in 1986 constituted gross income from sources without

the United States, whereas the interest income earned by

each of the other members of petitioner's affiliated group

for 1986 constitutes gross income from sources within the

United States.

The following schedule summarizes the revenue impact

of the position of each of the parties with respect to the

subject issue. It shows, based upon the parties'

stipulation, the aggregate interest expense apportioned to - 22 -

sources without the United States for each of the years in

issue as claimed on petitioner's consolidated returns, the

aggregate interest expense to be apportioned to foreign

sources if there is no netting of interest expense and

interest income, and the aggregate amount to be so

apportioned if there is netting of interest expense and

interest income. The last column of the schedule shows the

difference between the amount of interest to be apportioned

to sources without the United States, assuming that there

is no netting, and the amount of interest to be so

apportioned, assuming that there is netting:

Interest expense allocated and apportioned to sources without the United States

Year Per return No netting Netting Difference

1982 $55,704,104 $55,155,126 $17,444,643 $37,710,483 1983 50,434,920 47,362,922 17,200,130 30,162,792 1984 54,658,298 50,150,909 19,831,268 30,319,641 1986 45,205,129 45,517,890 37,689,610 7,828,280

206,002,451 198,186,847 92,165,651 106,021,196

Thus, as shown above, if there is netting, then the

aggregate interest expense to be allocated and apportioned

to sources without the United States in computing the

overall limitation on petitioner's foreign tax credit under

section 904(a) would be substantially less for each of the

4 years in issue than the interest expense to be allocated

and apportioned to sources without the United States if

there is no netting. This difference is $37,710,483,

$30,162,792, $30,319,641, and $7,828,280, for the years in - 23 -

issue, respectively. Thus, the effect of netting would be

to substantially increase petitioner's income from sources

without the United States, the numerator of the limiting

fraction under section 904(a), and to substantially

increase the amount of petitioner's foreign tax credit for

each of the years in issue.

Both parties rely on the regulations promulgated under

the source rules, viz sections 861 through 864, especially

section 1.861-8(e)(2), Income Tax Regs., to support their

position that netting is permitted or that netting is not

permitted. Petitioner does not contend that the

regulations are contrary to the statute or unlawful in

any respect. Therefore, as presented by the parties, the

issue in this case is whether the netting of interest

income and interest expense is permitted by the regulations

promulgated under sections 861 through 864, principally

section 1.861-8(e)(2), Income Tax Regs., that were in

effect during the years 1982, 1983, 1983, and 1986,

generally referred to herein as the subject regulations.

At the outset, we note that the principal regulation

at issue in this case, section 1.861-8(e)(2), Income Tax

Regs., was adopted on January 3, 1977, effective for

taxable years beginning after December 31, 1976 - 24 -

(hereinafter referred to as the 1977 Regulation).

42 Fed. Reg. 1197 (Jan. 6, 1977).

In 1988, the Secretary of the Treasury issued

temporary regulations dealing with the allocation and

apportionment of interest expense and certain other

expenses for purposes of the foreign tax credit rules and

certain other international tax provisions to reflect the

revisions to those rules made by the passage of the Tax

Reform Act of 1986, Pub. L. 99-514, sec. 1215, 100 Stat.

2544. Section 1.861-9T(a), Temporary Income Tax Regs.,

53 Fed. Reg. 35477 (Sept. 14, 1988), superseded the 1977

regulation for years beginning after December 31, 1986.

Section 1.861-9T(a) contains virtually the same language

found in section 1.861-8(e)(2)(i) and (ii) regarding the

allocations and apportionment of interest expenses. In

addition, section 1.861-9T(a), Temporary Income Tax Regs.,

supra, explicitly provides that "the term interest refers

to the gross amount of interest expense incurred by a

taxpayer in a given year." (Emphasis added.) Therefore,

the 1988 temporary regulation explicitly prohibits netting

for tax years beginning after December 31, 1986. The 1988

temporary regulations were not given retroactive effect

and thus do not apply to the years in issue in this case. - 25 -

See sec. 1.861-8T(h), Temporary Income Tax Regs., 53 Fed.

Reg. 35477 (Sept. 14, 1988).

We do not agree with petitioner's contention that,

by promulgating the new rules without retroactive effect,

the Secretary of the Treasury indicated "that the express

restrictive language requiring the use of gross interest

expense for purposes of allocation and apportionment was

intended as a change, rather than a clarification, of prior

law." To the contrary, the 1988 temporary regulations,

including section 1.861-9T(a), Temporary Income Tax Regs.,

supra, were promulgated to reflect the revisions made by

the Tax Reform Act of 1986, including the enactment of

section 864(e), which substantially changed some of the

rules for the allocation and apportionment of interest

expenses. These new provisions were made effective, for

the most part, for tax years beginning after December 31,

1986. Tax Reform Act of 1986, Pub. L. 99-514, sec.

1215(c)(1), 100 Stat. 2545. It was appropriate to make

the regulations reflecting those changes effective at the

same time. In these circumstances, we do not believe that

promulgating the new rules without retroactive effect

suggests that the sentence in section 1.861-9T(a),

Temporary Income Tax Regs., supra, quoted above, containing

the words, "the gross amount of interest expense", was - 26 -

law.

The subject regulations are intended to be used in

conjunction with certain "operative sections" of the Code

which require the determination of the taxable income of

the taxpayer from specific sources or activities. See

sec. 1.861-8(f)(1), Income Tax Regs. The overall

limitation on the foreign tax credit provided in section

904(a) is one such operative section. See id.

Under the subject regulations, the first step in

determining a taxpayer's taxable income from a particular

source or activity is to categorize the taxpayer's gross

income into different groupings. See sec. 1.861-8(a)(1),

(2), (4), Income Tax Regs. The regulations use the term

"statutory grouping of gross income" to mean the gross

income from a specific source or activity which must first

be determined in order to arrive at taxable income from

such specific source or activity under an operative

section. Sec. 1.861-8(a)(4), Income Tax Regs. Gross

income from other sources or activities is referred to

as the "residual grouping of gross income". Id.

The overall limitation of section 904(a), the

operative section in this case, requires the taxpayer to

determine taxable income from sources without the United - 27 -

States. Thus, the "statutory grouping of gross income" in

this case is gross income from sources without the United

States and the "residual grouping of gross income" is gross

income from sources within the United States. See sec.

1.861-8(a)(4), (f)(1), Income Tax Regs.

The term "gross income from sources without the United

States", the statutory grouping of gross income in this

case, consists of those items of gross income specified in

section 862(a), plus the items of gross income allocated

or apportioned to such sources in accordance with section

863(a). Sec. 1.861-1(a)(2), Income Tax Regs. Similarly,

"gross income from sources within the United States", the

residual grouping of gross income in this case, consists

of those items of gross income specified in section 861(a),

plus the items of gross income allocated or apportioned

to such sources in accordance with section 863(a). Sec.

1.861-1(a)(1), Income Tax Regs.

For example, in the case of interest income, section

861(a)(1) provides that, as a general rule, the interest

on bonds, notes, or other interest-bearing obligations of

residents of the United States, corporate or otherwise,

shall be treated as income from sources within the United

States. See sec. 1.861-2(a), Income Tax Regs. Section

862(a)(1) provides that interest income other than that - 28 -

derived from sources within the United States shall be

treated as income from sources without the United States.

See sec. 1.862-1(a)(1)(i), Income Tax Regs.

The record in the instant case does not expressly

provide the source of the interest income earned by any

member of petitioner's affiliated group of corporations

during any of the years in issue. Nevertheless, we infer

that the interest income of petitioner's affiliated

corporations, for the most part, would be treated under

the source rules as U.S. source income. Otherwise, if the

interest income of petitioner's affiliated corporations

were treated as foreign source income, then, in each case,

the interest income would be included in the numerator of

the limiting fraction under section 904(a) and would offset

the interest expenses in that grouping. Thus, if the

were foreign source income, netting would have little or no

impact on the amount of foreign tax credit. This inference

is confirmed in the case of the interest income earned by

the members of petitioner's group for 1986, as discussed

above.

After finding the source of each item of the

taxpayer's gross income and grouping the items of gross

income into the statutory and residual groupings, the next - 29 -

step in determining taxable income from a specific source

or activity is to allocate and apportion the taxpayer's

"expenses, losses, and other deductions" to each of the

groupings of gross income. Sec. 1.861-8(a)(2), (b), and

(c), Income Tax Regs. Taxable income from a particular

source or activity is the difference between the aggregate

items of gross income in that grouping and the sum of the

expenses, losses, and other deductions that are properly

allocated and apportioned thereto, and a ratable portion

of any expenses, losses, or other deductions that cannot

definitely be allocated to an item or class of gross

income. See secs. 861(b), 862(b); secs. 1.861-1, 1.861-

8(a)(1), Income Tax Regs.

The regulations provide rules of general applicability

governing the allocation and apportionment of expenses,

losses, and other deductions, see sec. 1.861-8(a), (b),

(c), and (d), Income Tax Regs., as well as rules governing

the allocation and apportionment of specific deductions,

see sec. 1.861-8(e)(2) through (11), Income Tax Regs.

Specific rules for the allocation and apportionment of

interest expense are provided in section 1.861-8(e), Income

Tax Regs.

The principal rule of general applicability is that a

taxpayer's expenses, losses, and other deductions are to be - 30 -

allocated to the "class of gross income" to which each

deduction is "definitely related". Sec. 1.861-8(a)(3),

(b)(1), Income Tax Regs. A deduction is considered

definitely related to a class of gross income if it is

incurred as a result of, or incident to, an activity or

in connection with property from which such class of gross

income is derived and, thus, the deduction bears a factual

relationship to the class of gross income. Sec. 1.861-

8(b)(1) and (2), Income Tax Regs. Classes of gross income

are not predetermined but must be determined on the basis

of the deductions to be allocated. Sec. 1.861-8(b)(1),

Income Tax Regs. They may consist of one or more items of

gross income enumerated in section 61, such as compensation

for services, gross income derived from business, gains

derived from dealings in property, interest, rents,

royalties, dividends, etc. Sec. 1.861-8(a)(3), (b)(1),

If a deduction is definitely related to a class of

gross income that is included in more than one grouping of

gross income, or if the deduction is definitely related to

all of the taxpayer's gross income, then the regulations

further provide that the deduction shall be apportioned "by

attributing the deduction to gross income (within the class

to which the deduction has been allocated) which is in the - 31 -

statutory grouping or in each of the statutory groupings

and to gross income (within the class) which is in the

residual grouping." Sec. 1.861-8(c)(1), Income Tax Regs.

This attribution must reflect to a reasonably close extent

the factual relationship between the deduction and the

grouping of gross income. See id. The method of

apportionment for a particular deduction can take into

consideration various bases and factors, such as a

comparison of units sold attributable to the statutory

grouping and to the residual grouping, a comparison of

the amount of gross sales or receipts, a comparison of the

costs of goods sold, a comparison of profit contribution,

a comparison of expenses incurred, assets used, salaries

paid, space utilized, and time spent which are attributable

to the activities or properties giving rise to the class of

gross income, and a comparison of the amount of gross

income in the statutory grouping with the amount in the

residual grouping. See id.

Finally, if the deduction is not definitely related to

any gross income, then the regulations provide that it is

to be apportioned ratably between the statutory grouping

and (or among the statutory groupings) and the residual

grouping in proportion to the amount of gross income in - 32 -

each grouping. See sec. 1.861-8(b)(5), (c)(2), Income

Thus, under the rules of general applicability, the

approach of the regulations, with several exceptions, is

that every deduction has a definite factual relationship to

a particular class of gross income which constitutes less

than all of the taxpayer's gross income. Based upon that

approach, the rules of general applicability require each

deduction to be allocated to the related class of gross

income and to be apportioned, on some reasonable basis, to

the statutory and residual groupings of gross income.

The regulations take a different approach in the

specific rules governing the allocation and apportionment

of interest expenses, set forth in section 1.861-8(e)(2),

Income Tax Regs. The regulations describe this approach

as follows:

(2) Interest–-(i) In general. The method of allocation and apportionment for interest set forth in this paragraph (e)(2) is based on the approach that money is fungible and that interest expense is attributable to all activities and property regardless of any specific purposes for incurring an obligation on which interest is paid. This approach recognizes that all activities and property require funds and that management has a great deal of flexibility as to the source and use of funds. Normally, creditors of a taxpayer subject the money advanced to the taxpayer to the risk of the taxpayer's entire activities and look to the general credit of the - 33 -

taxpayer for payment of the debt. When money is borrowed for a specific purpose, such borrowing will generally free other funds for other purposes and it is reasonable under this approach to attribute part of the cost of borrowing to such other purposes. For the method of determining the interest deduction allowed to foreign corporations under section 882(c), see sec. 1.882-5. [Sec. 1.861-8(e)(2)(i), Income Tax Regs.]

This is the provision of the regulations on which

petitioner principally relies, sec. 1.861-8(e)(2)(i),

Income Tax Regs. Based on the above approach, the

regulations provide as follows:

the aggregate of deductions for interest shall be considered related to all income producing activities and properties of the taxpayer and, thus, allocable to all the gross income which the income producing activities and properties of the taxpayer generate, have generated, or could reasonably have been expected to generate. [Sec. 1.861-8(e)(2)(ii), Income Tax Regs.]

After stating the general rule in section 1.861-

8(e)(2)(i), Income Tax Regs., that interest expense is

"allocable to all gross income" of the taxpayer, the

regulations provide various methods to apportion the

taxpayer's interest expense between the statutory

grouping of gross income (or among the statutory groupings

of gross income) and the residual grouping. See sec.

1.861-8(e)(2)(v) and (vi), Income Tax Regs. Under the - 34 -

"asset method", the deduction for interest is apportioned,

generally, in accordance with the value (book value or fair

market value) of the assets utilized or invested in the

activity or property. See sec. 1.861-8(e)(2)(v), Income

Tax Regs. This is the method that petitioner wishes to use

for tax years 1982, 1983, and 1984, as mentioned above.

Under the "optional gross income methods", the deduction

for interest is apportioned, generally, on the basis of the

gross income in the statutory grouping or groupings and in

the residual grouping. Sec. 1.861-8(e)(2)(vi), Income Tax

Regs. This is the method that petitioner wishes to use for

tax year 1986, as mentioned above.

Significantly, the regulations provide an exception

that applies in the case of interest incurred specifically

to purchase specific property. See sec. 1.861-8(e)(2)

(iv), Income Tax Regs. In that case, the interest is

treated as definitely related to the gross income derived

from the property and is apportioned accordingly. See id.

In order for this exception to apply, certain facts and

circumstances enumerated in the regulations must be found.

These include the fact that the indebtedness was incurred

to purchase the specific property, the fact that the

proceeds of the loan were actually applied to that purpose,

the fact that the property is the only security for the - 35 -

loan, the fact that the return (cashflow) on or from the

property will be sufficient to satisfy the payments under

the loan, and the fact that the loan agreements place

restrictions on the disposal or use of the property. See

id.

Where it is found that an interest deduction is

definitely related solely to specific property, the

interest deductions are allocated solely to the gross

income derived from the specific property. See sec. 1.861-

8(e)(2)(iv)(B), Income Tax Regs. Thus, the income from the

specific property is placed in a grouping of gross income

in accordance with the usual rules for sourcing gross

income, see secs. 1.861-2 through 1.861-7, Income Tax

Regs., and the interest deduction is directly allocated to

such gross income, see sec. 1.861-8(e)(2)(iv)(B), Income

Finally, in the case of nonbusiness interest, such

as interest paid by an individual on a mortgage on his

personal residence, the interest is treated as not

definitely related to any class of gross income, see sec.

1.861-8(b)(5), (c)(2), Income Tax Regs., and is apportioned

ratably between the statutory grouping (or among the

statutory groupings) and the residual grouping in - 36 -

proportion to the amount of gross income in each grouping,

see sec. 1.861-8(e)(2)(iii), Income Tax Regs.

Petitioner argues that, under the version of the

section 861 regulations in effect during the years in

issue, it "may allocate and apportion net interest, rather

than gross, interest expense" in calculating taxable income

from sources without the United states for purposes of

section 904(a). Petitioner's position is based on its

reading of section 1.861-8(e)(2)(i), Income Tax Regs.,

which is quoted above. Petitioner emphasizes that section

1.861-8(e)(2)(i), Income Tax Regs., states, in general,

that the method of allocation and apportionment for

interest is based on the approach that "money is fungible",

and recognizes that "all activities and property require

funds" and that "management has a great deal of flexibility

as to the source and use of funds." Id. Petitioner notes

that the regulation refers to "interest" as "the cost of

borrowing" in the context of "the fungibility of money".

Based thereon, petitioner argues that the language of the

regulation "raises a contextual ambiguity with respect to

the precise definition of 'interest' and 'the cost of

borrowing'." According to petitioner, the term "interest"

can mean either net interest or gross interest, depending

on the context. Petitioner argues that, in the context of - 37 -

the subject regulation which is based upon the fungibility

of money approach, and, absent an express rule to the

contrary, the term "interest" should be recognized to mean

net interest expense; i.e., gross interest expense less

interest income.

Petitioner asserts that the following "simplified

example", demonstrates that recognizing "interest" or "the

cost of borrowing" as net interest expense, implements the

fungibility of money principle:

Assume * * * that a business needs $800,000, and has $1 million in short-term instruments bearing interest at 10 percent per year, and the capacity to borrow funds with no fees and at 10 percent per year. The business can obtain the $800,000 by reducing its holding of short-term interest bearing instruments or by borrowing. Either choice has exactly the same effect on the net income of the business. If the business borrows, interest expense will increase by $80,000 per year; if the business sells the instruments, interest income will decrease by $80,000 per year.

Petitioner argues that the two sources of funds in the

above example, incurring debt and selling short-term

interest bearing assets, are fungible and should be treated

as fungible under the source rules, as would take place by

recognizing interest as net interest expense. Petitioner

also argues that "a corollary to the fungibility of these

two sources of funds is the fact that reduced interest - 38 -

income is essentially equivalent to increased interest

expense."

Petitioner gives the following variation of the above

example to illustrate its position that taxpayers in the

same economic situation should be treated the same by

interpreting "interest" and "cost of borrowing", as used

in section 1.861-8(e)(2)(i), Income Tax Regs., to mean net

interest:

Suppose business A has an immediate need of $800,000 and uncertain future needs, and a line of credit of $1 million at 10 percent, and immediately draws $800,000 on the line of credit. The interest expenses on the $800,000 would be $80,000, rather than $100,000. In contrast, business B has a substantially identical need of $800,000 immediately and uncertain future needs, but has no line of credit. So, business B obtains a loan from a bank for $1 million and invests the surplus $200,000 in short-term instruments bearing 10 percent. Although business B's gross interest expense would be $100,000, its cost of borrowing would be best described as $80,000 ($100,000-$20,000).

Petitioner argues that in the context of section 1.861-

8(e)(2), Income Tax Regs., which is based upon the

"fungibility of money" and management's "flexibility as to

sources of funds", the two firms in the above example are

in the same economic situation and the cost of borrowing

incurred by both firms should be treated the same, as would

take place by recognizing interest as net interest expense. - 39 -

Petitioner relies heavily on the Opinion of this Court

in Bowater, Inc., & Subs. v. Commissioner, 101 T.C. 207

(1993), revd. 108 F.3d 12 (2d Cir. 1997), involving the

same issue, viz, whether a taxpayer may offset interest

income and interest expense in determining the amount of

the interest deduction to be allocated and apportioned

under section 1.861-8(e)(2), Income Tax Regs. In that

case, the issue arose in the context of computing the

combined taxable income (CTI) of the taxpayer and its

domestic international sales corporation (DISC)

attributable to qualified export receipts derived from the

sale by the DISC of export property. See Bowater, Inc.,

& Subs. v. Commissioner, supra. Generally, in computing

CTI attributable to qualified export receipts, expenses are

to be allocated and apportioned in a manner consistent with

the rules set forth in section 1.861-8, Income Tax Regs.

Sec. 1.994-1(c)(6)(iii), Income Tax Regs. In Bowater,

Inc., & Subs. v. Commissioner, supra, we held that interest

expenses can be offset by interest income before the

net interest expense is apportioned under section 1.861-

8(e)(2), Income Tax Regs. Id.

Petitioner argues that we should follow Bowater, Inc.,

& Subs. v. Commissioner, supra, in the instant case, as we

have on two prior occasions, Coca Cola Co. v. Commissioner, - 40 -

106 T.C. 1, 6 (1996), and Computervision Intl. Corp. v.

Commissioner, T.C. Memo. 1996-131, vacated and remanded

164 F.3d 73 (1st Cir. 1999). Petitioner also argues that

we should reject the "faulty" reasoning of the Court of

Appeals for the Second Circuit in its opinion reversing

this Court's Bowater, Inc. opinion. See Bowater, Inc.,

& Subs. v. Commissioner, 108 F.3d 12 (2d Cir. 1997).

Respondent argues that the subject regulations are not

ambiguous. To the contrary, respondent states that the

"plain language of the Regulations" promulgated under

section 861 "[mandates] the apportionment of interest

expense among all income producing activities, including

those that generate interest income, and [rejects] the

'netting' of interest expense and interest income".

Respondent argues that this is made clear by two examples

in the regulations, Examples (1) and (24) of section

1.861-8(g), Income Tax Regs., in which "'gross' interest

expense, i.e., without reduction for interest income, [is

apportioned] among each of the hypothetical taxpayer's

income producing activities, including those that generate

interest income." Respondent also argues that petitioner

misinterprets "the Regulation's fungibility concept".

Finally, respondent argues that petitioner's position

ignores the fact that the regulations promulgated under - 41 -

section 861 apportion "deductions" which, in the case of

interest expenses means the amount deductible under section

163. In this connection, respondent points out that

section 1.861-8(a)(2), Income Tax Regs., is headed

"Allocation and apportionment of deductions in general",

and that "there is nothing in the Regulations suggesting

that the word 'deduction' should be defined differently

under Treas. Reg. §1.861-8 than elsewhere in the Internal

Revenue Code."

We disagree with petitioner that the language of

section 1.861-8(e)(2)(i), Income Tax Regs., "raises a

contextual ambiguity with respect to the precise

definition of the terms 'interest expense' and 'the cost

of borrowing.'" We also disagree that those terms were

intended, or can be interpreted in the context of section

1.861-8(e)(2), Income Tax Regs., to refer to "net interest

expense." In our view, the allocation and apportionment

of net interest expense under section 1.861-8(e)(2), Income

Tax Regs., is not permitted by the regulations; it would

subvert the operation of the source rules, and it would

lead to incongruous and erroneous results.

We believe that petitioner misconstrues section 1.861-

8(e)(2)(i), Income Tax Regs., and finds an ambiguity where

none exists. As discussed above, the rules of general - 42 -

applicability for the allocation and apportionment of

expenses, losses, and other deductions, set forth in

section 1.861-8(a), (b), and (c), Income Tax Regs., are

based on the approach that an expense, loss, or other

deduction should be allocated to a class of income,

composed of less than the taxpayer's entire gross income,

as to which the deduction bears a factual relationship,

and then, if necessary, apportioned between or among the

statutory and residual groupings of gross income. See sec.

1.861-8(a), (b), and (c), Income Tax Regs. On the other

hand, the rules that specifically govern the allocation

and apportionment of interest expenses, with two limited

exceptions, take the approach that interest expenses are

related to all income-producing activities and properties

of the taxpayer and thus are allocable to all of the

taxpayer's gross income. See sec. 1.861-8(e)(2)(i) and

(ii), Income Tax Regs.

The regulations state that the different approach

for allocating interest expenses is based on the fact

that "money is fungible and that interest expense is

attributable to all activities and property regardless of

any specific purpose for incurring an obligation on which

interest is paid." Sec. 1.861-8(e)(2)(i), Income Tax Regs.

Thus, the regulations use the phrase "money is fungible" - 43 -

in section 1.861-8(e)(2)(i), Income Tax Regs., simply to

explain why the rules specifically dealing with interest

expenses allocate interest expenses to all of the

taxpayer's gross income, whereas the rules of general

applicability treat other deductions as related to one

or more classes of income.

In order to facilitate our discussion of the

positions of the parties, it is helpful to review the

following example. Assume that during the year a taxpayer,

a domestic corporation, had gross operating income from

domestic sales of $800,000, gross operating income from

foreign sales of $500,000, operating expenses of $300,000

attributable to domestic sales, and operating expenses of

$200,000 attributable to foreign sales. Assume further

that, during the same year, the taxpayer realized interest

income from U.S. sources of $200,000 and interest expense

of $375,000. Finally, assume that the ratio of the value

of the assets which relate to activities and properties

that generate foreign source income to the value of all

of the taxpayer's assets is the same as the ratio of the

taxpayer's gross income from foreign sources to total gross

income. Based upon these facts, the computation of the

taxpayer's taxable income from U.S. and foreign sources,

assuming that netting is not permitted, and the proportion - 44 -

of each to the taxpayer's entire taxable income, as

contemplated by section 904(a), are shown in the following

schedule:

No netting Total U.S. source Foreign source Gross income Operating income $1,300,000 $800,000 $500,000 Interest income 200,000 200,000 -0-

Total 1,500,000 1,000,000 500,000 Gross income ratio 100% 66.67% 33.33%

Expenses Operating expenses 500,000 300,000 200,000 Interest expense 375,000 250,000 125,000 Total 875,000 550,000 325,000

Taxable income 625,000 450,000 175,000

Section 904(a) ratio 100% 72% 28%

Petitioner's position, is that section 1.861-8(e)(2)

(i), Income Tax Regs., permits a taxpayer to offset

interest expense with interest income before "net interest

expense" is allocated and apportioned under section 1.861-

8(e)(2), Income Tax Regs., to the different groupings of

gross income for purposes of computing the taxpayer's

taxable income in each grouping. Based on petitioner's

position, the computation of the taxpayer's taxable income

from U.S. and foreign sources, and the proportion of each

to the taxpayer's entire taxable income as contemplated by

section 904(a), are shown in the following schedule: - 45 - With netting Total U.S. source Foreign source Gross income Operating income $1,300,000 $800,000 $500,000 Interest income -0- -0- -0- Total 1,300,000 800,000 500,000 Gross income ratio 100% 61.54% 38.46%

Expenses Operating expenses 500,000 300,000 200,000 Interest expense 175,000 107,692 67,308 Total 675,000 407,692 267,308

Taxable income 625,000 392,308 232,692

Sec. 904(a) ratio 100% 62.7692% 37.2308%

Thus, in this example, the netting of interest expense and

interest income has the effect of increasing, from 28

percent to 37.23 percent, the proportion of the taxpayer's

taxable income, $625,000, that is attributable to foreign

sources.

There are several consequences of netting that should

be noted. First, in order for the netting computation to

arrive at the taxpayer's correct taxable income, i.e.,

$625,000 in the above example, the taxpayer's total gross

income must be reduced by the amount of interest income

that is offset against interest expense. This adjustment

is necessary because only net interest expense is allocated

and apportioned to the statutory grouping (i.e., foreign

source) and the residual grouping (i.e., United States

source) under section 1.861-8(e)(2), Income Tax Regs.

Accordingly, the aggregate deductions used in the netting

computation are less than actual aggregate deductions. - 46 -

Thus, taxpayer's taxable income, i.e., the difference

between the gross income in both groupings and the

aggregate expenses allocated and apportioned thereto, will

be overstated, unless the taxpayer's total gross income is

reduced by the amount of interest income that was offset.

Continuing the above example, if interest expense and

interest income are netted for purposes of allocating

interest expenses but the amount of interest income offset

by netting is not removed from the taxpayer's gross income,

then the computation contemplated by section 904(a) would

be as follows:

With netting Total U.S. source Foreign source Gross income Operating income $1,300,000 $800,000 $500,000 Interest income 200,000 200,000 -0- Total 1,500,000 1,000,000 500,000 Gross income ratio 100% 66.67% 33.33%

Expenses Operating expenses 500,000 300,000 200,000 Interest expense 175,000 116,667 58,333 Total 675,000 416,667 258,333

Taxable income 825,000 583,333 241,667 1 1 1 Sec. 904(a) ratio 132% 93.3333% 38.6667%

1 Based upon taxable income of $625,000.

Thus, as illustrated above, if the taxpayer's gross income

is not reduced, then the taxpayer's taxable income,

$625,000, would be overstated by the amount of the interest

income that is offset by interest expense, $200,000, and

the section 904(a) ratio would not be based upon the - 47 -

taxpayer's "entire taxable income for the same taxable

year". Sec. 904(a). This raises a question about where in

the regulations is there authority to reduce "gross income"

by the amount of netted interest.

Second, an equally important consequence of netting is

the fact that it increases the ratio under section 904(a),

and thus increases the amount of foreign tax credit, only

to the extent that the interest income that is absorbed by

interest expense in the netting process is from U.S.

sources. To the extent that a relatively greater amount of

the interest income absorbed in the netting process is from

foreign sources, then netting produces a lower ratio under

section 904(a) than not netting.

In the above example, we assumed that all of the

interest income, $200,000, was from U.S. sources. In that

case, the section 904(a) ratio computed without netting was

28 percent but was increased to 37.23 percent by netting.

On the other hand, if we assume that the interest income is

entirely from foreign sources, then the section 904(a)

ratio, without netting, is 52 percent, computed as follows: - 48 - No netting Total U.S. source Foreign source Gross income Operating income $1,300,000 $800,000 $500,000 Interest income 200,000 -0- 200,000

Total 1,500,000 800,000 700,000 Gross income ratio 100% 53.33% 46.67%

Expenses Operating expenses 500,000 300,000 200,000 Interest expense 375,000 200,000 175,000

Total 875,000 500,000 375,000

Taxable income 625,000 300,000 325,000

Sec. 904(a) ratio 100% 48% 52%

If interest expense and interest income are netted,

however, the ratio is reduced to 37.23 percent. Thus, even

though the taxpayer received all of his interest income

from foreign sources under the regulations dealing with

interest income, sec. 1.861-2, Income Tax Regs., netting

disregards the source of the interest income that is

absorbed by interest expenses and causes the taxpayer to

obtain the same foreign tax credit as another taxpayer who

realized interest income entirely from U.S. sources. This

example demonstrates that the netting of interest expense

and interest income which petitioner argues arises from

section 1.861-8(e)(2)(i), Income Tax Regs., fails to take

into account the source of the interest income, and it

causes interest income from entirely different sources to

be treated the same. - 49 -

In our view, petitioner's position that it "may

allocate and apportion net, rather than gross, interest

expense under section 1.861-8(e)(2), Income Tax Regs." is

foreclosed by the language of that regulation. Section

1.861-8(e)(2)(ii), Income Tax Regs., provides that "the

aggregate of deductions for interest" are allocable to

"all the gross income" of the taxpayer for the year. As we

read it, section 1.861-8(e)(2)(ii), Income Tax Regs., thus

directs that the gross amount of the taxpayer's interest

deductions, i.e., the aggregate of deductions for interest,

be allocated to all of the taxpayer's gross income. In

effect, section 1.861-8(e)(2)(ii), Income Tax Regs.,

forecloses petitioner's position that net interest expense,

i.e., less than "the aggregate of deduction for interest",

can be allocated to less than "all of the taxpayer's gross

income", i.e., the excess of the taxpayer's gross income

over the portion of the taxpayer's interest income that is

offset by interest expenses.

Furthermore, petitioner's position that it "may

expense" is foreclosed by sections 861(a)(1), 862(a)(1),

and the regulations promulgated thereunder, including

sections 1.861-2(a) and 1.862-1(a), Income Tax Regs. Those - 50 -

provisions define "gross income from sources within the

United States" and "gross income from sources without the

United States" to include all of the interest income earned

by the taxpayer during the taxable year. Secs. 1.861-2(a),

1.862-1(a), Income Tax Regs. In computing gross income

from sources within and without the United States, neither

the statute nor the regulations contemplate that the

portion of the taxpayer's gross income consisting of

interest income for the year will be reduced or entirely

As shown in the hypothetical example discussed above,

such a reduction of the amount of the taxpayer's gross

income would be necessary in a netting computation.

Otherwise, the computation would overstate the taxpayer's

taxable income for the year by the interest income that

is offset by interest expense. The adjustment to gross

income that would be necessary is depicted in the

computation set forth in the hypothetical discussed above.

It is similar to the adjustment that the parties made in

computing the taxpayer's interest expense for 1986 as shown

in the appendix.

Moreover, petitioner's position that it is entitled to

allocate net interest expense under section 1.861-8(e)(2), - 51 -

Income Tax Regs., means that the taxpayer's interest

income, to the extent that it is offset by interest

expense, is not included in the groupings of gross income,

i.e. gross income from sources within and without the

United States, contrary to sections 861(a)(1) and

862(a)(1). Sec. 861(a)(1). Thus, in our view, interest

netting would subvert the operation of the source rules.

Generally, as discussed above, the source rules

operate by assigning items of gross income to different

groupings of gross income, such as income from sources

within and without the United States, in accordance with

standards set out in the statute, and by allocating and

apportioning the taxpayer's expenses, losses, and other

deductions to the different groupings. Items of gross

income that constitute interest are assigned to groupings

of gross income from sources within and without the United

States generally in accordance with the residence of the

payor. See sec. 1.861-2, Income Tax Regs.

Under interest netting, interest income is offset by

interest expense and only net interest expense is allocated

and apportioned under the source rules. In effect, the

source of the interest income that is offset is not taken

into account in the groupings of gross income and taxable - 52 -

income, as contemplated under the source rules. Netting

would, thus, subvert the operation of those rules.

Netting would also lead to the incongruous and

erroneous results depicted in the hypothetical example

discussed above in which a taxpayer who realized interest

income entirely from foreign sources is treated the same as

a taxpayer who realized the same interest income entirely

from United States sources. As discussed above, to the

extent that a relatively greater amount of interest income

absorbed in the netting process is from foreign sources,

then netting actually produces a lower taxable income from

foreign sources than not netting.

As mentioned above, the issue in this case was first

decided in connection with the 1977 Regulations, in

Bowater, Inc., & Subs. v. Commissioner, 101 T.C. 207

(1993). In light of the opinion of the U.S. Court of

Appeals for the Second Circuit reversing our opinion in

Bowater, Inc., it is appropriate to reconsider our Bowater,

Inc. opinion. It is also appropriate to reconsider

Bowater, Inc., in light of the opinion of the U.S. Court

of Appeals for the Fifth Circuit in Dresser Indus., Inc.

v. United States, 238 F.3d 603 (5th Cir. 2001), in which

that court holds that interest netting is not permitted - 53 -

under section 1.861-8(e)(2), Income Tax Regs. In this

connection, we note that our opinion in Bowater, Inc.,

in part, had relied upon the reasoning of a prior opinion

of the U.S. Court of Appeals for the Fifth Circuit

involving the predecessor of the 1977 regulation, Dresser

Indus., Inc. v. Commissioner, 911 F.2d 1128 (5th Cir.

1990), revg. 92 T.C. 1276 (1989). Following our

reconsideration of this issue, we now agree with both the

U.S. Courts of Appeals for the Second and Fifth Circuits

that the subject regulation, section 1.861-8(e)(2), Income

Tax Regs., does not permit the netting of interest income

and interest expense. In light of that, we hereby overrule

our opinion in Bowater, Inc., & Subs. v. Commissioner, 101

T.C. 207 (1993).

For reasons set forth above,

An appropriate order will be

issued granting respondent’s

motion in limine.

Reviewed by the Court.

SWIFT, GERBER, RUWE, COLVIN, HALPERN, BEGHE, CHIECHI, LARO, FOLEY, VASQUEZ, GALE, and MARVEL, JJ., agree with this opinion.

WELLS and THORNTON, JJ., did not participate in the consideration of this opinion. - 54 -

Appendix

1982 Interest Net interest Asset ratio Interest apportioned to foreign expense expense percent source income No netting Netting 650 Leasing Co. $682,931 -0- 34.34 $234,519 -0-

Sun Leasing Co. 4,729,086 $3,216,310 64.81 3,064,921 $2,084,491

666 Leasing Co. 4,072,539 2,167,684 64.98 2,646,336 1,408,561

670 Leasing Co. 1,830,136 89,166 69.96 1,280,363 62,381

673 Leasing Co. 1,627,381 374,085 55.98 911,008 209,413

675 Leasing Co. 1,983,276 1,146,615 60.65 1,202,857 695,422

652 Leasing Co. 794,330 -0- 73.42 583,197 -0-

Kee Leasing Co. 581,235 567,862 44.47 258,475 252,528

653 Leasing Co. 814,727 -0- 89.11 726,003 -0-

667 Leasing Co. 3,286,585 647,476 80.00 2,629,268 517,981

Millcreek Leasing Co. 830,407 -0- 4.26 35,375 -0-

De Sun Shipping 47,658 -0- 0.58 276 -0-

Eastern Sun Shipping 37,115 -0- 0.51 189 -0-

NY Sun Shipping 9,970,340 9,116,332 90.23 8,996,238 8,225,666

NJ Sun Shipping 143,340 127,135 3.76 5,390 4,780

PA Shipping 46,423 -0- 2.70 1,253 -0-

Phil Sun Shipping 10,809,958 10,361,281 29.54 3,193,262 3,060,722

Western Sun Shipping 50,003 -0- 0.00 -0- -0-

Sun Transport, Inc. 3,650,045 3,550,205 25.99 948,647 922,698

Sun Note Co. 31,066,253 -0- 91.39 28,391,449 -0-

North Sea Oil Co. 65,897 -0- 34.77 22,912 -0-

Totem Ocean Trailer 46,949 -0- 49.39 23,188 -0-

Total 77,166,614 31,364,151 55,155,126 17,444,643 - 55 -

1983 Interest Net interest Asset ratio Interest apportioned to foreign expense expense percent source income No Netting Netting 650 Leasing Co. $612,220 -0- 27.22 $166,646 -0-

Sun Leasing Co. 4,736,241 $3,154,840 63.17 2,991,883 $1,992,912

666 Leasing Co. 4,084,197 2,376,712 53.36 2,179,328 1,268,214

670 Leasing Co. 1,756,214 617,207 71.74 1,259,908 442,784

672 Leasing Co. 714,282 82,784 57.18 408,426 47,336

Kee Leasing Co. 504,412 497,647 43.41 218,965 216,029

653 Leasing Co. 736,315 77,583 67.56 497,454 52,415

667 Leasing Co. 3,160,356 1,670,995 83.00 2,623,095 1,386,926

Millcreek Leasing Co. 742,214 -0- 5.85 43,420 -0-

NY Sun Shipping 9,849,306 9,122,147 83.33 8,207,427 7,601,485

NJ Sun Shipping Co. 208,102 -0- 1.97 4,100 -0-

Phil Sun Shipping 10,688,995 9,833,854 29.29 3,130,807 2,880,336

Texas Sun Shipping 33,963 -0- 4.56 1,549 -0-

Tropic Sun Shipping 474,700 -0- 27.47 130,400 -0-

Sun Transport, Inc. 2,644,781 1,664,584 20.58 544,296 342,571

Heleasco Fifteen 1,444,639 1,197,778 80.91 1,168,857 969,122

Sun Note Co. 25,667,812 -0- 92.67 23,786,361 -0-

Total 68,058,749 30,296,131 47,362,922 17,200,130 - 56 -

1984 Interest Net interest Asset ratio Interest apportioned to foreign expense expense percent source income No netting Netting Kee Leasing Co. $408,197 $397,659 17.77 $72,537 $70,664

666 Leasing Co. 4,083,327 1,874,164 33.48 1,367,098 627,470

670 Leasing Co. 1,669,360 299,856 48.22 804,965 144,591

650 Leasing Co. 536,038 -0- 6.90 36,987 -0-

652 Leasing Co. 613,066 -0- 38.08 233,456 -0-

653 Leasing Co. 636,635 -0- 25.12 159,923 -0-

667 Leasing Co. 3,018,359 1,406,484 37.98 1,146,373 534,183

Sun Leasing Co. 4,689,864 2,645,034 44.68 2,095,431 1,181,801

NY Sun Shipping 9,712,823 9,180,293 86.91 8,441,414 7,978,593

Phil Sun Shipping 10,551,646 9,875,526 35.37 3,732,117 3,492,974

Tropic Sun Shipping 644,883 -0- 12.02 77,515 -0-

Sun Transport, Inc. 3,091,754 3,056,531 16.87 521,579 515,637 1 Sun Oil Trading Co. 627,633 -0- 0.00 -0- -0-

Sun Note Co. 25,854,099 -0- 93.06 24,059,825 -0-

North Sea Sun Oil Co. 7,681,288 5,485,009 96.36 7,401,689 5,285,355

Total 73,818,972 34,220,556 50,150,909 19,831,268

1 See p. 9, supra - 57 -

1986 No netting Gross Asset income Gross ratio Interest ratio §1.861-8(e) §1.861-8(e) §1.861-8(e) Interest 2 income Foreign GI percent expense percent (2)(vi)(A) (2)(vi)(B)(1) (2)(vi)(B)(2) apportioned

Kee Leasing Co. $2,013,346 $260,455 4.71 $213,410 12.94 $27,608 - - $27,608 666 Leasing Co. 7,082,756 3,172,987 18.63 3,907,731 44.80 1,750,615 - - 1750,615 670 Leasing Co. 3,533,401 1,496,424 42.66 1,468,580 42.35 621,956 - - 621,956 650 Leasing Co. 2,038,955 954,294 0.00 404,732 46.80 189,427 - - 189,427 Sun Leasing Co. 6,194,365 2,679,882 0.00 4,532,004 43.26 1,960,691 - - 1,960,691 Millcreek 1 Leasing Co. 305,752 -83,676 0.53 435,448 0.00 - $1,154 - 1,154 Tropic Sun Shipping 3,986,919 1,501,298 2.73 644,829 37.66 242,814 - - 242,814 Sun Transport, Inc. 79,520,790 21,932,881 20.91 2,356,829 27.58 650,044 - - 650,044 Sunoco Overseas, Inc. -108,199 290,314 0.00 211,438 100.00 - - $105,719 105,719 Sun Refining & Marketing Co. 672,597,605 1,095,517 20.27 44,588,973 0.16 - 4,519,092 - 4,519,092 Sun Oil Trading Co. 13,481,454 4,673,000 0.00 549,406 34.66 190,437 - - 190,437 3 3 Sun Co., Inc. 760,884,991 23,864,572 6.47 157,687,537 3.14 - 5,097,676 - 5,097,676 Sun Oil Intl. 19,593,916 6,769,393 34.60 7,190,703 34.55 2,484,276 - - 2,484,276 North Sea Sun Oil Co. 36,565,327 36,394,917 97.00 28,050,064 99.53 - - 27,629,313 27,629,313 Claymont Investment Co. 513,112,873 111,203 0.00 217,180,793 0.02 47,068 - - 47,068 Total 2,120,804,251 105,113,461 469,422,477 45,517,890

1 Cannot reconcile this amount with the fact that this corporation realized interest income of $646,275 during 1986. 2 Foreign source gross income divided by total gross income. 3 It appears that this amount should be $5,101,192 (i.e., $157,687,537 x 6.47 percent x 50 percent). - 58 -

1986 Netting Gross Asset income ratio Interest Interest ratio §1.861-8(e) §1.861-8(e) §1.861-8(e) Interest Gross income Foreign GI percent expense income Net interest percent4 (2)(vi)(A) (2)(vi)(B)(1) (2)(vi)(B)(2) apportioned

Kee Leasing Co. $2,013,346 $260,455 4.71 $213,410 $9,844 $203,566 13.00 $26,464 - - $26,464 666 Leasing Co. 7,082,756 3,172,987 18.63 3,907,731 736,783 3,170,948 50.00 1,585,474 - - 1,585,474 670 Leasing Co. 3,533,401 1,496,424 42.66 1,468,580 540,553 928,027 50.00 464,014 - - 464,014 650 Leasing Co. 2,038,955 954,294 0.00 404,732 130,367 274,365 50.00 137,183 - - 137,183 Sun Leasing Co. 6,194,365 2,679,882 0.00 4,532,004 834,601 3,697,403 50.00 1,848,702 - - 1,848,702 Millcreek - 1 Leasing Co. 305,752 -83,676 0.53 435,448 662,752 -0- 0.00 -0- - -0- Tropic Sun Shipping 3,986,919 1,501,298 2.73 644,829 1,148,919 -0- 44.92 -0- - - -0- Sun Transport, Inc. 79,520,790 21,932,881 20.91 2,356,829 646,275 1,710,554 27.81 475,659 - - 475,659 Sunoco Overseas, Inc. -108,199 290,314 0.00 211,438 189,663 21,775 100.00 - - 10,888 10,888 Sun Refining & 5 Marketing Co. 672,597,605 1,095,517 20.27 44,588,973 23,675,379 20,913,594 0.14 - 2,119,593 - 2,119,593 Sun Oil Trading Co. 13,481,454 4,673,000 0.00 549,406 317,610 231,796 35.50 82,285 - - 82,285 6 6 Sun Company Inc. 760,884,991 23,864,572 6.47 157,687,537 937,176 156,750,361 3.14 - 5,067,379 - 5,067,379 Sun Oil Intl. 19,593,916 6,769,393 34.60 7,190,703 12,824,523 -0- 54.58 -0- - - -0- North Sea 7 Sun Oil Co. 36,565,327 36,394,917 97.00 28,050,064 1,784,106 26,265,958 99.51 - - 25,871,969 25,871,969 Claymont Investment Co. 513,112,873 111,203 0.00 217,180,793 505,319,941 -0- 0.04 -0- - - -0- Total 2,120,804,251 105,113,461 469,422,477 549,758,492 214,168,347 37,689,970

1 Cannot reconcile this amount with the fact that this corporation realized interest income of $646,275 during 1986. 4 Foreign source gross income divided by the excess of total gross income over interest income. 5 It appears that this percentage should be 0.17 percent (i.e., $1,095,517 ÷ ($672,597,605 - $23,675,379)). 6 It appears that this amount should be $5,070,874 (i.e., $156,750,361 x 6.47 percent x 50 percent). 7 Interest income treated as foreign source income. Thus in computing the allocation ratio, 99.51 percent, interest income is removed from both the numerator and the denominator of the fraction (($36,394,917 - $1,784,106) ÷ ($36,565,327 - $1,784,106)).