107 T.C. No. 5
UNITED STATES TAX COURT
TEXASGULF INC. AND SUBSIDIARIES, AS SUCCESSOR IN INTEREST TO TEXASGULF INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15528-89. Filed September 9, 1996.
Under the Ontario Mining Tax (OMT), mine operators are generally liable for a tax on gross receipts less deductions for several expenses and a processing allowance. P paid the OMT and claimed a foreign tax credit under sec. 901, I.R.C.
P and R agree that sec. 1.901-2, Income Tax Regs., applies to the years at issue. R concedes that the OMT is a tax and that it meets realization and gross income requirements imposed by those regulations but contends that the OMT does not meet the net income requirement. Sec. 1.901-2(b)(4), Income Tax Regs.
A foreign tax meets the net income requirement if it meets any one of three tests. Under one of those - 2 -
tests, a foreign tax meets the net income requirement if, judged on the basis of its predominant character, the base of the tax is computed by reducing gross receipts to permit recovery of significant expenses under a method that is likely to approximate or exceed those expenses. Sec. 1.901-2(b)(4)(i)(B), Income Tax Regs.
Held: Whether, judged by the predominant character of the OMT, the processing allowance is likely to approximate or exceed expenses related to gross receipts which are nonrecoverable under the OMT is a question of fact. Accord Texasgulf, Inc. v. United States, 17 Cl. Ct. 275 (1989), modified per order (Apr. 16, 1992).
Held, further, P has proven that, judged on the basis of the predominant character of the OMT, the processing allowance is likely to approximate or exceed expenses related to gross receipts which are nonrecoverable under the OMT. Inland Steel Co. v. United States, 233 Ct. Cl. 314, 677 F.2d 72 (1982), distinguished (sec. 1.901-2, Income Tax Regs., did not apply).
Willard B. Taylor, Richard J. Urowsky, Michael Lacovara, C.
Barr Flinn, Ann T. Kenny, Jared M. Rusman, and Scott L. Lessing,
for petitioner.
Lewis R. Mandel, Monica E. Koch, and Christopher W. Shoen,
for respondent.
COLVIN, Judge: Respondent determined deficiencies in
petitioner’s Federal income tax of $563,127 for 1979, $10,998,770
for 1980, and $1,794,073 for 1981. The sole issue for decision - 3 -
is whether the Ontario Mining Tax (OMT) is creditable under
section 901. We hold that it is.
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
A. Petitioner and Kidd Creek Mine
Petitioner was a Delaware corporation the principal place of
business of which was in Stamford, Connecticut, when it filed the
petition.
Petitioner is the successor in interest to Texasgulf Inc., a
Texas corporation which filed consolidated Federal income tax
returns for taxable years 1978, 1979, 1980, and 1981, as the
parent of Texasgulf Canada. Texasgulf Canada discovered the Kidd
Creek mineral reserves near Timmins, Ontario, Canada, in 1964.
Texasgulf Canada explored the reserves, acquired some land claims
from current owners, and began to develop the reserves.
Texasgulf Canada was incorporated in Delaware in 1965 as
Ecstall Mining Ltd. (Ecstall). In 1966, Texasgulf Canada
transferred the Kidd Creek land claims to Ecstall. At that time,
the property had a significant amount of mineral reserves and
substantial value. Ecstall began mining and concentrating
operations at Kidd Creek Mine in 1966. Kidd Creek Mine is an - 4 -
open pit mine at which ore from a copper, zinc, lead, and silver
deposit is produced. In 1966, Kidd Creek Mine had a concentrator
which was about 17 miles from the mine. A railroad connected
them.
Texasgulf Canada owned and operated the Kidd Creek Mine from
1968 to 1981. From 1968 to 1980, Texasgulf Canada crushed the
ore from Kidd Creek Mine into pieces 7½ inches or smaller.
Texasgulf Canada then put the ore in storage bins and carried it
by rail to the concentrator for further processing. The
concentrator further crushed, pulverized, and concentrated the
ore.
Ecstall changed its name to Texasgulf Canada Ltd. in 1975
and to Kidd Creek Mines Ltd. in 1981. Texasgulf Canada was
subject to the OMT because it mined and processed ore at Kidd
Creek Mine. Texasgulf Canada paid OMT of $934,238 for 1978,
$12,437,280 for 1979, and $18,307,052 for 1980.
B. The Ontario Mining Industry and the Production of Metal
Many metallic and nonmetallic minerals are mined and
produced in Ontario. Metallic minerals mined in Ontario include
base metals such as nickel, copper, and zinc, and precious metals
such as gold, silver, and platinum. Nonmetallic minerals mined
in Ontario include asbestos, peat, gypsum, talc, and salt. - 5 -
Generally, metal production in Ontario and elsewhere has
four phases: (1) Exploration; (2) development; (3) mining; and
(4) processing.
1. Exploration
The exploration phase consists of finding and delineating
ore reserves. These activities range from prospecting to
exploring by aircraft with advanced scientific techniques such as
electromagnetic and seismic surveying. Texasgulf Canada
discovered minerals near the Kidd Creek Mine by using airborne
exploration techniques.
2. Development
The development phase includes activities needed to bring a
mineral reserve into production. For an underground mine,
development activities include sinking a shaft, adit (an almost
horizontal entrance to a mine), or ramp from the surface of the
ground into the mineral reserves. For an open pit mine, such as
the Kidd Creek Mine, development activities include removing
waste rock that separates the ore from the surface.
3. Mining
The mining phase is the process of extracting ore from the
ground, typically by blasting and mechanical removal.
4. Processing
The processing phase generally includes three different
stages: (a) Milling or concentrating; (b) smelting; and (c) - 6 -
refining. Milling is the process of separating waste rock from
ore, generally through chemical treatment, to produce “concen-
trate”. Copper concentrate, for example, is approximately 20-25
percent copper. A mill or concentrator is built at or near
virtually every mine in Ontario.
Smelting is the process of converting concentrate into a
relatively pure product. A copper smelter, for example, produces
about 99 percent pure copper.
Refining is the process of producing pure metal from smelted
product by heat-induced chemical reactions, electrolytic methods,
solvent extraction, hydro metallurgical methods, or
vapometallurigical methods.
It is rare for a mining company to buy mineral property
outright in Ontario. For this reason, Ontario mining companies
typically do not incur high costs to acquire reserves and,
consequently, do not have high cost depletion.
Small entities called junior exploration companies do much
of the exploring for new mining properties in Ontario.
Typically, junior exploration companies do not have enough
financial resources to produce the ore they find. The junior
company, once it has identified a body of ore, usually enters
into an agreement with an established producer under which the
producer does additional work on the property in exchange for an
ownership interest in it. If the additional work by the senior - 7 -
company shows that the property should be developed, the junior
company and the senior company typically agree for the junior
company to keep an ownership interest in the property.
C. The Ontario Mining Tax (OMT)
1. Application of the OMT
The OMT applies to every mine in Ontario to the extent that
its OMT profits exceed a statutory exemption. Mining Tax Act
(MTA), Rev. Stat. Ont. (R.S.O.), ch. 140, sec. 3 (1972). In most
cases, the OMT is imposed on the mine operator. Id. sec. 2(2).
The mine operator is the party that has the right to produce and
sell minerals from the mine. Id. sec. 1(g). The OMT does not
apply to holders of royalties.
2. OMT Profit
Profit for OMT purposes is the difference between either
gross receipts from production or pit’s mouth value and certain
expenses, payments, allowances, and deductions. Id. sec. 3(3).
Under the MTA, there are three ways to calculate the amount from
which deductions and allowances are subtracted to compute profit
for OMT purposes. Id. sec. 3(3)(a), (b), and (c). First, if an
OMT taxpayer sells ore without processing it, gross revenues are
the total receipts from selling the ore. Id. sec. 3(3)(a).
Second, if an OMT taxpayer processes ore before selling it, the
OMT taxpayer subtracts deductions and allowances from the market
value at the pit’s mouth of the mined minerals. Id. sec. - 8 -
(3)(3)(b). Third, if an OMT taxpayer does not know the market
value of the output at the pit's mouth, deductions and allowances
are subtracted from the value of the ore at the pit's mouth as
appraised by the mine assessor to compute profit for OMT
purposes. Id. sec. (3)(3)(c).
Most OMT taxpayers use the third method, also known as the
“appraisal” method, to calculate profit for OMT purposes. This
method is not based on the on-site value of ore; it is based on
financial statements and other information included on an OMT
return.
The OMT exempts some taxable profit. Ontario has increased
the exemption over the years. The statutory exemption was (a)
$10,000 before 1969, MTA, R.S.O., ch. 242, sec. 3(1) (1960); (b)
$50,000 from 1969 to 1973, An Act to Amend The Mining Tax Act,
R.S.O. ch. 69, sec. 2(1) (1969); (c) $100,000 from 1974 to 1979,
An Act to Amend The Mining Tax Act of 1972, R.S.O. ch. 132, sec.
2(1) (1975); and (d) $250,000 beginning in 1979, An Act to Amend
The Mining Tax Act of 1972, R.S.O. ch. 40, sec. 1 (1979).
3. Deductions for Expenses
An OMT taxpayer calculates its profit for OMT purposes by
deducting specified expenses from either the pit’s mouth value or
its gross receipts from production. MTA, R.S.O., ch. 140, sec.
3(3). The MTA allows an OMT taxpayer to deduct expenses for:
(a) Scientific research in Canada relating to mining in Ontario - 9 -
(added MTA, R.S.O., ch. 269, sec. 3(7)(d) (1980)); (b) working
the mine above and below the ground, including salaries and wages
for miners and office workers; (c) operations and maintenance
(added MTA, R.S.O., ch. 269, sec. 3(7)(d) (1980)); (d) power and
light for mining; (e) transportation of minerals; (f) food and
provisions; (g) explosives, fuel, and other supplies; (h)
safeguarding the mine and its output; (i) insurance on the
output, mining plant, machinery, equipment, and buildings; (j)
depreciation of the mining plant, machinery, equipment, and
buildings; (k) charitable donations; and (l) certain costs of
developing a mine. Id. sec. 3(3)(d) through (n). In 1978, 1979
and 1980, an OMT operator could claim a depreciation allowance
from 5 to 15 percent of the remaining undepreciated cost of its
depreciable assets. Id. sec. 3(3)(k) (1972).
An OMT taxpayer may not deduct expenses for (a) plant,
machinery, equipment, or buildings except as described above; (b)
investment capital, investment interest, or stock dividends; (c)
depreciation in the value of the mine, mining land, or mining
property due to exhaustion of the ore or mineral; (d) royalties
paid for the output of a mine on private (i.e., non-Crown) land;
and (e) the cost of developing a mine, except as described above.
Id. sec. 3(4). Exploration expenses were not recoverable in
1965, but are recoverable in the years in issue. - 10 -
4. Processing Allowance
Most OMT taxpayers can deduct a processing allowance under
the third method for calculating OMT profit.1 Id. sec.
3(3)(c)(i) and (ii) (as amended in 1975); Ont. Rev. Regs. 126/75,
sec. 4 (1975). During the years in issue, the processing
allowance was calculated at a rate prescribed by the regulations
or determined by the mine assessor. MTA, R.S.O., ch. 269, sec.
3(7)(c)(ii). The processing allowance was a percentage of the
cost of assets used to process a mined product (asset cost basis)
or a percentage of profits from mining and processing activities
(combined profits). Ont. Rev. Regs. 126/75, sec. 5 (1975). An
OMT taxpayer which used the asset cost basis method multiplied
the original cost of assets by a percentage which varied based on
which processing assets the mine operator owned (e.g.,
concentrator, smelter, refinery, and semi-fabricating plant) and
where those assets were located (e.g., in Northern Ontario). Id.
The minimum processing allowance was 15 percent of combined
profits. Id. sec. 5(5). The maximum processing allowance was 65
percent of the OMT taxpayer's combined profits. Id.
Most mine operators claimed the 65 percent amount. The
processing allowance was zero if an operator had no taxable
1 The processing allowance is not available to mining companies that do not process mined material, e.g., gypsum, salt, etc. These are very insignificant in numbers and dollars in Ontario. - 11 -
profits or had a loss for a taxable year. There is nothing
analogous to the processing allowance in financial accounting.
5. Calculating OMT Liability
Most OMT taxpayers started to calculate the OMT with net
income from mining and processing reported on their financial
statements. OMT taxpayers adjusted their financial statement net
income by adding expenses which the MTA did not allow to be
recovered and subtracting items of income not related to Ontario
mining and processing. OMT taxpayers made these adjustments by
reconciling OMT taxable income and financial statement net
income. OMT taxpayers computed taxable profit by deducting
specified expenses, payments, allowances, and deductions as
described above. MTA, R.S.O., ch. 140, sec. 3(3) (1972).
D. The Mine Assessor
During the years in issue, the Mine Assessor was responsible
for enforcing the Mining Tax Act. The Mine Assessor encouraged
taxpayers to comply with the MTA, administered the MTA,
interpreted and applied the MTA and its regulations, recommended
policy related to mineral taxation, and developed and implemented
tax assessment standards. The Mine Assessor reviewed all OMT
returns, either confirmed or changed the liability that the OMT
taxpayer reported, and assessed the OMT due from operators.
Mine operators who disagreed with the Mine Assessor's
determinations could appeal to the Minister of Natural Resources. - 12 -
The Minister of Natural Resources referred the appeal to the
Mining Commissioner or the Ontario Municipal Board to be tried
and decided.
In 1986, the position of Mine Assessor was renamed Senior
Manager of the Mining Tax. In 1993, it was renamed Manager of
the Mining Tax. The duties of these positions are the same as
those of the Mine Assessor described above.
Kumara Rachamalla (Rachamalla) was appointed Mine Assessor
in 1980 and served in that position (as renamed) until the date
of trial.
E. Texasgulf Canada’s OMT Liability, Nonrecoverable Expenses, and Processing Allowance
Texasgulf Canada's total processing allowance for 1968 to
1980 was Can$468,106,000, and its nonrecoverable expenses were
Can$340,787,000. Texasgulf Canada had financial statement net
income, OMT profit and depreciation, nonrecoverable expenses, and
processing allowances as follows: - 13 -
(Thousands of Can$)
Financial OMT Statement OMT Nonrecoverable Processing Year Profit Net Income Depreciation Expenses Allowance 1968 56,814 68,843 11,710 8,712 10,026 1969 47,423 61,049 12,384 10,793 8,368 1970 46,834 62,730 14,509 10,203 8,264 1971 32,033 49,479 16,057 11,705 6,032 1972 33,559 43,844 9,100 23,000 17,843 1973 99,548 109,706 9,591 31,809 22,985 1974 109,383 162,537 32,503 32,400 37,973 1975 34,737 90,809 30,081 21,042 42,622 1976 32,529 79,506 16,296 25,545 60,411 1977 100 39,515 54,147 27,245 185 1978 6,521 38,610 57,843 38,378 12,111 1979 51,742 130,249 6,755 39,827 96,092 1980 78,181 199,546 14,636 60,128 145,194 Total 629,404 1,136,423 285,612 340,787 468,106
The nonrecoverable expenses are as follows:
Financial Other Non- Statement Private recoverable Year Depreciation Interest Royalties Expenses Total 1968 5,188 -0- 3,249 275 8,712 1969 5,589 -0- 2,959 2,245 10,793 1970 4,213 146 5,425 419 10,203 1971 4,089 4,031 3,074 511 11,705 1972 6,757 12,072 2,787 1,384 23,000 1973 9,577 15,590 5,011 1,631 31,809 1974 8,246 11,879 8,639 3,636 32,400 1975 6,553 8,289 5,037 1,163 21,042 1976 8,221 10,769 3,428 3,127 25,545 1977 7,771 14,820 485 4,169 27,245 1978 10,993 21,521 2,451 3,413 38,378 1979 8,321 24,009 2,569 4,928 39,827 1980 9,937 30,688 10,743 8,760 60,128 Total 95,455 153,814 55,857 35,661 340,787
F. Comparison of Processing Allowances and Nonrecoverable Expenses for Other OMT Taxpayers
From 1968 to 1980, the processing allowance exceeded
nonrecoverable expenses for most OMT taxpayers. For those years,
total processing allowances claimed by OMT taxpayers were more
than three times greater than nonrecoverable expenses. Total - 14 -
processing allowances exceeded nonrecoverable expenses each year
from 1968 to 1980 except 1971 and 1977.
G. Respondent’s Determination and Petitioner’s Election
On March 29, 1989, respondent issued a notice of deficiency
to petitioner for 1979, 1980, and 1981. Respondent did not
determine a deficiency for 1978, but adjusted petitioner’s net
operating loss to be carried forward from 1978 to 1979.
Petitioner timely elected for section 1.901-2, Income Tax Regs.,
to apply in deciding whether its OMT and other Canadian taxes are
creditable under section 901.
OPINION
A. Background and Contentions of the Parties
The parties dispute whether the OMT is creditable under
section 901. Our decision on this issue depends on whether the
OMT is an income tax under section 1.901-2, Income Tax Regs.
A taxpayer may deduct foreign taxes unless the taxpayer
elects and is entitled to use the foreign tax credit. Sec.
901(a). If a taxpayer is a citizen or a domestic corporation,
the taxpayer may be entitled to a credit for any income, war
profits, and excess profits tax paid or accrued during the
taxable year to a foreign country or possession of the United
States. Sec. 901(b)(1).2
2 SEC. 901(b) provides in pertinent part:
(continued...) - 15 -
The purpose of the foreign tax credit is to "mitigate the
evil of double taxation" of domestic corporations on income from
foreign sources. Burnet v. Chicago Portrait Co., 285 U.S. 1, 7
(1932); New York & Honduras Rosario Mining Co. v. Commissioner,
168 F.2d 745, 747 (2d Cir. 1948), revg. and remanding 8 T.C. 1232
(1947). A credit against U.S. income tax is, in effect, an
exemption from taxation, and is dependent upon legislative grace.
Keasbey & Mattison Co. v. Rothensies, 133 F.2d 894, 898 (3d Cir.
1943). A taxpayer who claims a foreign tax credit must show that
it clearly comes within the statute that allows the credit. Id.
Petitioner bears the burden of proof. Rule 142(a). The “reaches
of the word ‘income’ in section 901(b)(1) have been the subject
of a long and tortuous history” in terms of legislative
background, the decided cases, and respondent's rulings, which
history is “permeated” with “vagaries, confusion, and * * *
contradictions”. Bank of America Natl. Trust & Sav. Association
v. Commissioner, 61 T.C. 752, 759 (1974), affd. without published
2 (...continued) Sec. 901(b). Amount Allowed.--Subject to the limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):
(1) Citizens and domestic corporations.--In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States * * * - 16 -
opinion 538 F.2d 334 (9th Cir. 1976). In Bank of America Natl.
Trust & Sav. Association v. United States, 198 Ct. Cl. 263, 459
F.2d 513, 523 (1972), the U.S. Court of Claims concluded that an
income tax for purposes of section 901(b):
covers all foreign income taxes designed to fall on some net gain or profit, and includes a gross income tax if, but only if, that impost is almost sure, or very likely, to reach some net gain because costs or expenses will not be so high as to offset the net profit. [Fn. ref. and citation omitted.]
B. Section 1.901-2, Income Tax Regs.
Respondent proposed regulations under section 901 in 1979,
sec. 1.901-2, Proposed Income Tax Regs., 44 Fed. Reg. 36071
(June 20, 1979), and issued temporary regulations in 1980, sec.
4.901-2, Temporary Income Tax Regs., 45 Fed. Reg. 75647 (Nov. 17,
1980); see Phillips Petroleum Co. v. Commissioner, 104 T.C. 256,
285 (1995)(construing these temporary regulations). On April 5,
1983, respondent issued new proposed regulations. Sec. 1.901-2,
Proposed Income Tax Regs., 48 Fed. Reg. 14640 (Apr. 5, 1983).
The regulations under section 901, section 1.901-2, Income Tax
Regs., were adopted on October 12, 1983. T.D. 7918, 1983-2 C.B.
113. The parties do not dispute that the regulations apply to
petitioner for the years in issue.
To understand how the regulations apply here, we must
consider a series of defined terms and phrases in the
regulations. We begin with the definition of income tax. The
regulations define income tax as follows: - 17 -
§ 1.901-2. Income, war profits, or excess profits tax paid or accrued.--(a) Definition of income, war profits, or excess profits tax--(1) In general. * * * Whether a foreign levy is an income tax is determined independently for each separate foreign levy. A foreign levy is an income tax if and only if--
(i) It is a tax; and
(ii) the predominant character of that tax is that of an income tax in the U.S. sense.
Except to the extent otherwise provided in paragraphs (a)(3)(ii) and (c) of this section, a tax either is or is not an income tax, in its entirety, for all persons subject to the tax. * * *
Sec. 1.901-2(a)(1), Income Tax Regs.
Respondent concedes that the OMT is a tax under section
1.901-2(a)(2)(i), Income Tax Regs. However, the parties dispute
whether the "predominant character of the tax is that of an
income tax in the U.S. sense." The regulations describe that
requirement as follows:
(3) Predominant character. The predominant character of a foreign tax is that of an income tax in the U.S. sense--
(i) If, within the meaning of paragraph (b)(1) of this section, the foreign tax is likely to reach net gain in the normal circumstances in which it applies * * *
Sec. 1.901-2(a)(3), Income Tax Regs.
Thus, for a tax to be creditable under the regulations, it
must be likely to reach net gain in the normal circumstances in - 18 -
which it applies.3 Under the regulations, that standard is met
"if and only if the tax, judged on the basis of its predominant
character" meets specified realization, gross receipts, and net
income requirements. Sec. 1.901-2(b)(1), Income Tax Regs. The
regulations provide in part as follows:
(b) Net gain--(1) In general. A foreign tax is likely to reach net gain in the normal circumstances in which it applies if and only if the tax, judged on the basis of its predominant character, satisfies each of the realization, gross receipts, and net income requirements set forth in paragraphs (b)(2), (b)(3) and (b)(4), respectively, of this section.
Sec. 1.901-2(b)(1), Income Tax Regs.
Respondent concedes that the OMT meets the realization and
gross receipts requirements but contends that it does not meet
the net income requirement of section 1.901-2(b)(4), Income Tax
Regs. Thus, for present purposes the OMT is creditable,
according to section 1.901-2(b)(1), Income Tax Regs., "if and
only if" it meets the net income requirement.
A foreign tax meets the net income requirement of section
1.901-2(b)(4), Income Tax Regs.,4 if, judged on the basis of its
3 This standard was first used in Bank of America Natl. Trust & Sav. Association v. United States, 198 Ct. Cl. 263, 459 F.2d 513, 517-518 (1972). One commentator said that "Fortunately, the regulations provide specific tests for determining whether the general Bank of America standard is satisfied." Dolan, "General Standards of Creditability Under Sections 901 and 903 Final Regulations -- New Words, Old Concepts”, 13 Tax Mgt. Intl. J. (BNA) 167, 169 (1984). 4 Sec. 1.901-2(b)(4), Income Tax Regs., provides: (continued...) - 19 -
predominant character, the base of the tax is computed by
reducing gross receipts to permit --
(1) recovery of significant costs and expenses attributable
to gross receipts, sec. 1.901-2(b)(4)(i)(A), Income Tax Regs.; or
(2) recovery of significant costs and expenses computed
under a method that is likely to produce an amount that
approximates, or is greater than, recovery of such significant
costs and expenses, sec. 1.901-2(b)(4)(i)(B), Income Tax Regs.
A foreign tax also meets the net income requirement of
section 1.901-2(b)(4), Income Tax Regs., if it provides
allowances that "effectively compensate" for nonrecovery of
4 (...continued) (4) Net income -- (i) In general. A foreign tax satisfies the net income requirement if, judged on the basis of its predominant character, the base of the tax is computed by reducing gross receipts (including gross receipts as computed under paragraph (b)(3)(i)(B) of this section) to permit--
(A) Recovery of the significant costs and expenses (including significant capital expenditures) attributable, under reasonable principles, to such gross receipts; or
(B) Recovery of such significant costs and expenses computed under a method that is likely to produce an amount that approximates, or is greater than, recovery of such significant costs and expenses.
A foreign tax law that does not permit recovery of one or more significant costs or expenses, but that provides allowances that effectively compensate for nonrecovery of such significant costs or expenses, is considered to permit recovery of such costs or expenses. * * * - 20 -
significant costs or expenses. Sec. 1.901-2(b)(4) (flush
language), Income Tax Regs. Petitioner prevails if the OMT meets
one or more of these net income requirements.
A recap may be helpful. The task of deciding whether the
predominant character of the OMT is that of an income tax in the
U.S. sense is simplified because the terms and clauses in the
regulations just described tie the "predominant character"
inquiry to several specific tests. To summarize, for a tax to be
creditable:
1. Its predominant character must be that of an income tax
in the U.S. sense. Sec. 1.901-2(a)(1)(ii), Income Tax Regs.
2. Its predominant character is that of an income tax in
the U.S. sense if it is “likely to reach net gain in the normal
circumstances in which it applies”. Sec. 1.901-2(a)(3)(i),
Income Tax Regs.
3. It is likely to reach net gain in the normal
circumstances in which it applies if and only if the tax, judged
on the basis of its predominant character, meets (among other
requirements) the net income requirement. Sec. 1.901-2(b)(1),
4. It meets the net income requirement if, judged on the
basis of its predominant character,5 it meets one of three tests.
5 To borrow a phrase, the "reader by now has divined that 'predominant character' is the leitmotif of the 1983 (continued...) - 21 -
Sec. 1.901-2(b)(4), Income Tax Regs. We next consider whether it
meets one of these tests.
C. Whether the OMT Meets the Net Income Requirement in Section 1.901-2(b)(4)(i)(B), Income Tax Regs.
Under one of the three net income tests, a tax meets the net
income requirement if, judged on the basis of its predominant
character, the base of the tax is computed by reducing gross
receipts to permit recovery of significant costs and expenses
approximates or exceeds recovery of such significant costs or
expenses. Sec. 1.901-2(b)(4)(i)(B), Income Tax Regs. Because of
respondent's concessions, the OMT is creditable if it meets that
test.
1. Consideration of Representative OMT Data
Petitioner offered evidence intended to prove that the
processing allowance is likely to approximate or exceed
nonrecoverable expenses. Petitioner's evidence consisted of a
broadly representative study of OMT tax returns filed from 1968
to 1980. Petitioner's study showed that the processing allowance
far exceeded the nonrecoverable expenses both in the aggregate
for all returns studied and for a large majority of OMT returns.
5 (...continued) regulations." Isenbergh, "The Foreign Tax Credit: Royalties, Subsidies, and Creditable Taxes", 39 Tax L. Rev. 227, 272 (1984). - 22 -
We agree with petitioner that use of broadly representative
data is an appropriate way to show whether the processing
allowance is likely to exceed nonrecoverable expenses. Two
factors lead us to that conclusion. First, both the processing
allowance and the amount of nonrecoverable expenses vary from
year to year and from taxpayer to taxpayer. Whether one is
likely to exceed the other is a factual question. Accord
Texasgulf, Inc. v. United States, 17 Cl. Ct. 275 (1989), modified
per order (Apr. 16, 1992). Whether the processing allowance is
likely to approximate or exceed nonrecoverable expenses can be
shown by actual OMT data. Second, we think it is appropriate to
consider industry data because a foreign tax either is or is not
an income tax, in its entirety, for all persons subject to it.
Sec. 1.901-2(a)(1) (flush language), Income Tax Regs.6 Whether a
tax is creditable for all persons subject to it can be shown by
multiyear data from a broadly representative group of taxpayers
subject to the tax.
2. Expert Testimony
Petitioner's expert was Robert B. Parsons (Parsons). He
prepared a report entitled “Study of Ontario Mining Tax Returns”
(Parsons OMT Report) and an “Overview of the Ontario Mining
6 See Dolan, supra note 3. - 23 -
Industry”.7 The Parsons OMT Report was based on a review of 213
OMT returns that represented about 80 percent of the total OMT
paid from 1968 to 1980. The mining operators which filed those
returns had about 68 percent of Ontario’s mineral production
during that period.
William J. Hallett (Hallett) was respondent’s expert. He
testified about the OMT returns that Parsons analyzed. Parsons
prepared a memorandum that rebutted parts of Hallett’s testimony.
We are not bound by the opinion of any expert witness, and
we may accept or reject expert testimony exercising our sound
judgment. Helvering v. National Grocery Co., 304 U.S. 282, 295
(1938); Fitts’ Estate v. Commissioner, 237 F.2d 729, 732-733 (8th
Cir. 1956), affg. T.C. Memo. 1955-269; IT & S of Iowa, Inc. v.
Commissioner, 97 T.C. 496, 508 (1991).
3. Petitioner's Study of OMT Taxpayers
Respondent concedes that the Parsons OMT Report included a
representative cross-section of OMT taxpayers. Only one
significant taxpayer did not give its OMT tax returns to Parsons
for the study. Respondent's expert stated that this taxpayer's
information would not have materially changed the results of the
7 Kumara Rachamalla was petitioner’s other expert. Respondent objected to our consideration of his report and testimony. Canadian law precluded him from revealing the data upon which he based his opinion and answering questions about this data on cross-examination. He agreed with Parsons’ conclusion in every material aspect. However, we have not considered his report or testimony in deciding this case. - 24 -
Parsons OMT Report. Parsons analyzed returns as filed; i.e.,
before assessment by the Mine Assessor. Later, Parsons obtained
records of the Mine Assessor’s adjustments to the filed returns.
He included assessment data in his rebuttal memorandum to the
extent it was available. The parties stipulated that the data
(but not the opinions and conclusions) in the Parsons OMT Report
was accurate.
Of the 213 returns that Parsons reviewed, 145 returns (68.1
percent) reported OMT liability. Nonrecoverable expenses exceed
the processing allowance on only 19 of the OMT returns which
reported OMT liability (15.8 percent).
The Parsons OMT Report shows that, in the aggregate,
processing allowances claimed by OMT taxpayers dwarfed
nonrecoverable expenses:
Millions of Can$
Nonrecoverable Processing Year Expenses Allowance 1968 10.6 91.6 1969 9.7 76.3 1970 30.2 99.7 1971 39.6 36.9 1972 51.7 92.6 1973 54.1 140.6 1974 57.6 196.8 1975 61.6 252.2 1976 70.0 217.8 1977 73.3 43.2 1978 83.4 94.7 1979 64.1 321.8 1980 99.3 573.5 Total 705.2 2,237.7 Average 54.3 172.1 - 25 -
For the 13-year period, the total amount of processing
allowance claimed on returns in the Parsons OMT Report was
Can$2,237,700,000, which is more than three times the total
amount of nonrecoverable expenses (Can$705,200,000).
Parsons concluded that the aggregate amount of processing
allowance claimed by OMT taxpayers in his report exceeded their
aggregate amount of nonrecoverable expenses by 3.2 to 1.
Respondent does not dispute that conclusion. Total processing
allowances claimed on returns exceeded nonrecoverable expenses
for 11 of the 13 years in the Parsons OMT Report.
The Parsons OMT Report also shows that the processing
allowances claimed by the vast majority of OMT taxpayers in the
study exceeded those taxpayers' nonrecoverable expenses. The
Parsons OMT Report also shows that nonrecoverable expenses
exceeded processing allowances in 21 of 145 returns from eight
OMT taxpayers.
4. Respondent’s Expert
Hallett concluded that nonrecoverable expenses exceeded the
processing allowance in only 60 of 213 OMT returns in the Parsons
OMT Report if all OMT returns are considered, whether or not tax
was due. Nineteen of those 60 returns were from taxpayers that
owed OMT.
Hallett stated his opinion that the nonrecoverable expenses
were significant. His opinion, even if correct, does not affect - 26 -
the result here. We need not decide whether nonrecoverable costs
are significant because we decide the case by considering whether
the processing allowance is likely to exceed nonrecoverable
expenses under section 1.901-2(b)(4)(i)(B), Income Tax Regs. The
question under section 1.901-2(b)(4)(i)(B), Income Tax Regs, is
not whether the nonrecoverable expenses are significant; it is
whether the processing allowance is likely to approximate or
exceed them.8
5. Conclusion
Petitioner has shown that the processing allowance exceeded
nonrecoverable expenses both in the aggregate and for the vast
majority of OMT taxpayers. We conclude that the OMT processing
allowance was likely to approximate or exceed the nonrecoverable
expenses for the years in issue.
D. Respondent’s Contentions
Respondent contends that petitioner has not proven that the
OMT meets the requirements of section 1.901-2(b)(4)(i)(B), Income
Tax Regs., because, according to respondent, (1) this case is
governed by cases decided before the 1983 regulations applied,
8 Similarly, we need not decide the parties’ dispute about the concept of pit’s mouth value. Respondent contends that the OMT’s use of pit’s mouth value shows that no nexus exists between the amount of the processing allowance and nonrecoverable expenses. Sec. 1.901-2((b)(4)(i)(B), Income Tax Regs., requires us to consider whether the processing allowance approximates or exceeds nonrecoverable expenses, not whether there is a nexus between the two. See par. D-3, infra p. 33. - 27 -
such as Inland Steel Co. v. United States, 230 Ct. Cl. 314, 677
F.2d 72 (1982); and also by Texasgulf, Inc. v. United States, 17
Cl. Ct. 275 (1989); (2) the OMT is not creditable unless its
predominant character is that of an income tax for each OMT
taxpayer; and (3) for the OMT to be creditable, the processing
allowance must have been intended to compensate for
nonrecoverable expenses. We address each of these contentions
next.
1. Extent To Which This Case Is Governed by Cases Decided Before the Regulations Were Issued and by Texasgulf, Inc. v. United States
a. Preamble to the 1983 Regulations
Respondent contends that the OMT is not creditable because
it fails to meet standards of creditability applied in cases
decided before the regulations were issued. Respondent contends
that the Preamble to section 1.901-2, Income Tax Regs., shows
that the regulations adopted prior case law. We disagree; the
preamble does not support respondent’s broad use of the
preregulation cases.
The preamble to the final regulations under section 901,
T.D. 7918, 1983-2 C.B., 113, 114, states in part:
Under these final regulations, the predominant character of a foreign tax is that of an income tax in the U.S. sense if the foreign tax is likely to reach net gain in the normal circumstances in which it applies. This standard, found in §1.901-2(a)(3)(i), adopts the criterion for creditability set forth in Inland Steel Company v. U.S., 677 F.2d 72 (Ct. Cl. 1982), Bank of America National Trust and Savings - 28 -
Association v. U.S., 459 F.2d 513 (Ct. Cl. 1972), and Bank of America National Trust and Savings Association v. Commissioner, 61 T.C. 752 (1974). The regulations set forth three tests for determining if a foreign tax is likely to reach net gain: the realization test, the gross receipts test, and the net income test. All of these tests must be met in order for the predominant character of the foreign tax to be that of an income tax in the U.S. sense.
The preamble states that the regulations adopt the
creditability criterion from certain cases to use in deciding
whether the predominant character of a foreign tax is likely to
reach net gain for purposes of section 1.901-2(a)(3)(i), Income
Tax Regs. The preamble states that a tax is likely to reach net
gain if it meets three tests provided in the regulations. The
regulations provide objective and quantitative standards that
were not used in cases which decided creditability of foreign
taxes before the regulations became final. Regulations can
supersede prior case law to the extent that they provide
requirements and definitions not found in prior case law. See
Bowater Inc. v. Commissioner, 101 T.C. 207, 212 (1993); Nissho
Iwai American Corp. v. Commissioner, 89 T.C. 765, 776-777 (1987).
b. Inland Steel Co. v. United States and Texasgulf, Inc. v. United States
Respondent contends that Inland Steel Co. v. United States,
supra, and Texasgulf, Inc. v. United States, supra, establish as
a matter of law that the OMT is not creditable. We disagree with
respondent’s contention that either of those cases decided the
issue before us here. - 29 -
The U.S. Court of Claims held in Inland Steel Co. v. United
States, supra, that the OMT was not creditable and that, for 1964
and 1965, the OMT paid by Caland Ore Co. did not fit the U.S.
concept of an income tax primarily because there were significant
nonrecoverable expenses (i.e., land expenses, rent, and private
royalties). Id. at 85, 87. In Inland Steel, the U.S. Court of
Claims evaluated Caland data for 1964 and 1965. In 1964, Caland
could not claim a processing allowance because it sold only
unprocessed ore. Id. at 79, 81. In 1965, Caland could claim a
processing allowance equal to not less than 15 percent or more
than 65 percent of the profits of the combined mining and
processing operations because it sold both unprocessed ore and
processed iron pellets. Id. at 81. Caland reported the minimum
15 percent of combined profits processing allowance on its OMT
return for 1965. Id. The record in that case did not include
OMT returns for any other OMT taxpayers or any other years.
The U.S. Court of Claims decided Inland Steel before the
1983 regulations were issued. In Inland Steel, the U.S. Court of
Claims analyzed the history and purpose of the OMT and held that
a foreign tax was creditable only if it was the “substantial
equivalent” of an income tax in the United States. Id. at 79;
see also New York & Honduras Rosario Mining Co. v. Commissioner,
168 F.2d at 749. The 1979 proposed regulations included a form
of the substantial equivalence test. Sec. 1.901-2(c), Proposed - 30 -
Income Tax Regs., 44 Fed. Reg. 36074 (June 20, 1979). However,
this standard was dropped by the final regulations issued in 1983
and replaced with a “predominant character” test. The use of the
“predominant character” and “effectively compensates” tests in
section 1.901-2(b)(4), Income Tax Regs., is a change from the
history and purpose approach used in the cases decided before the
1983 regulations applied a factual, quantitative approach. This
change to a quantitative approach is also made by the provision
of the 1983 regulations which provides that the predominant
character of a foreign tax is that of an income tax in the U.S.
sense, if, among other things, the foreign tax “is likely to
reach net gain in the normal circumstances in which it applies”.
Sec. 1.901-2(a)(3)(i), Income Tax Regs.
We have considered the parties’ use of industry data in this
case. See par. C-1, supra p. 21. The record contains broadly
representative data which shows that the OMT processing allowance
effectively compensates for the disallowed deductions. See par.
C-3 and 4, supra pp. 22, 24. The U.S. Court of Claims in Inland
Steel Co. v. United States, 230 Ct. Cl. 314, 677 F.2d 72 (1982),
did not have industry-wide data to consider, and the Secretary
had not yet promulgated regulations using a quantitative
approach. The court in Inland Steel did not discuss the
relationship between nonrecoverable expenses and the OMT
processing allowance. Based on the Parsons OMT Report, Caland's - 31 -
situation was unusual because most OMT taxpayers could and did
claim a processing allowance equal to 65 percent of the maximum
combined profits. Thus, the use of the processing allowance by
Caland was not typical. For the foregoing reasons, we conclude
that we are not bound by Inland Steel in deciding this case.9
Respondent points out that Inland Steel Co. v. United
States, supra, focused on the significance of expenses that are
nonrecoverable under the OMT. As discussed in paragraph C-4,
supra p. 25, we need not decide whether the nonrecoverable
expenses are significant under section 1.901-2(b)(4)(i)(A),
Income Tax Regs., because we hold that petitioner meets the
requirements under section 1.901-2(b)(4)(i)(B), Income Tax Regs.
In Texasgulf, Inc. v. United States, 17 Cl. Ct. 275 (1989),
the U.S. Claims Court granted the Government's motion for partial
summary judgment. The U.S. Claims Court later modified that
ruling in an unpublished order. Texasgulf, Inc. v. United
States, No. 532-83T (Cl. Ct., Apr. 16, 1992) (order partially
denying summary judgment). In that order, the U.S. Claims Court
reaffirmed its opinion in Texasgulf, Inc. v. United States,
supra, that nonrecoverable expenses under the OMT were
significant as a matter of law under Inland Steel Co. v. United
States, 677 F.2d at 85. However, in that order, the U.S. Claims
9 We note also that exploration expenses were not recoverable in Inland Steel Co. v. United States, 230 Ct. Cl. 314, 677 F.2d 72 (1982), but are fully recoverable in the years in issue. - 32 -
Court reversed its holding that the OMT processing allowance does
not effectively compensate for expenses that may not be recovered
under the OMT as a matter of law. Texasgulf, Inc. v. United
States, No. 532-83T (Cl. Ct. Apr. 16, 1992) (order partially
denying summary judgment). Thus, the U.S. Claims Court treats
that issue as a question of fact. The U.S. Claims Court left for
decision based on an appropriate record the question whether the
OMT processing allowance effectively compensates for the
disallowed deductions. Texasgulf, Inc. v. United States, No.
532-83T (Cl. Ct. Apr. 16, 1992) (order partially denying summary
judgment). Our record enables us to make a factual finding on
this point; as discussed above, we have found that, judged on the
predominant character of the OMT, the processing allowance is
likely to exceed nonrecoverable expenses.
2. Whether the Predominant Character of the OMT Must Be An Income Tax in the U.S. Sense for Each Taxpayer
Respondent contends that, for a tax to be creditable, its
predominant character must be that of an income tax in the U.S.
sense for each taxpayer subject to it. Respondent bases this
argument on the following language from the regulations: "a tax
either is or is not an income tax, in its entirety, for all
persons subject to the tax." Sec. 1.901-2(a)(1) (flush
language), Income Tax Regs. We disagree. This phrase does not
mean that, to be creditable, a tax must be an income tax for each
taxpayer subject to it; it means that a tax is creditable by - 33 -
either all, or none, of the taxpayers subject to it, regardless
of variations in how the tax applies to each taxpayer subject to
it.
Respondent contends that petitioner may not use aggregate
data to show that the OMT is creditable. Respondent also
contends that if we adopt petitioner’s position, the Commissioner
would be required to evaluate each OMT taxpayer every year to
determine whether its OMT payment was creditable. We disagree.
Use of aggregate data is appropriate because a tax is or is not
creditable for all taxpayers subject to it. This conclusion does
not require the Commissioner to evaluate each OMT taxpayer every
year to determine whether its OMT payment is creditable.
3. Whether the Processing Allowance Must Be Intended To Compensate for Nonrecoverable Expenses
Respondent contends that, for the OMT to be creditable, the
processing allowance must be intended to compensate for
nonrecoverable expenses. Respondent points out that the
processing allowance is computed without considering the amount
of nonrecoverable expenses and contends that the amount of one
bears no predictable relationship to the amount of the other.
Respondent contends that the fact that the processing allowance
exceeds nonrecoverable expenses for most OMT taxpayers does not
make the OMT creditable because that relationship is
coincidental. We disagree. - 34 -
The regulations do not provide that the processing allowance
must bear a predictable relationship to nonrecoverable expenses.
The regulations do provide that a foreign tax meets the net
income requirement if (among other requirements), judged by its
predominant character, the tax permits the recovery of
nonrecoverable expenses under a method that is likely to produce
an amount that approximates or is greater than the amount of the
nonrecoverable expenses. Sec. 1.901-2(b)(4)(i)(B), Income Tax
Regs. The effect of respondent’s position would be to exclude
from section 1.901-2(b)(4)(i)(B), Income Tax Regs., the words “or
is greater than”.
E. Conclusion
We conclude that the OMT processing allowance meets the
requirements of section 1.901-2(b)(4)(i)(B), Income Tax Regs.,
and that the OMT is creditable under section 901 for the years in
issue.
To reflect the foregoing and concessions,
Decision will be entered
under Rule 155.