DOJ Argues Royalty Income is Passive Income for Calculating FTC

L'Air Liquide, S.A. (L'Air), a French corporation, is the parent of AAL, which is the common parent of a group of corporations filing consolidated returns. Liquid Air Corp. (LAC) is a member of AAL's affiliated group. In 1986, AAL acquired the LAC research facilities and rights to all technical information developed or being developed by LAC. Under license agreements among AAL, LAC, and L'Air, AAL and LAC received royalties in 1989 through 1991 from L'Air for licenses to exploit outside the United States certain technical information developed at LAC's facilities. AAL characterized the royalties received from L'Air as section 904(d)(1)(I) general limitation income for foreign tax credit purposes. The IRS recharacterized the royalties as section 904(d)(1)(A) passive income, resulting in deficiencies.

The Tax Court dismissed AAL's assertion that Article 24(3) of the U.S.-France income tax treaty, the capital nondiscrimination provision, should apply, noting that AAL is a domestic corporation and the tax treatment of its foreign source royalty income is determined in exactly the same manner as for any other domestic corporation receiving such income. The court noted that the ultimate parent of AAL being a French corporation does not change the result and granted the government's motion for summary judgment. (For a summary, see Tax Notes, Jan. 22, 2001, p. 490; for the full text, see Doc 2001-1643 (14 original pages) [PDF] or 2001 TNT 11-24 .)

The Justice Department argues that the Tax Court correctly held that the royalties received by AAL from its French parent were passive income for FTC purposes and properly rejected AAL's contention that those royalties should instead be classified as "general limitation income." The DOJ also contends that classifying the royalties paid to AAL by its foreign parent as passive income for FTC purposes does not violate the U.S.-France income tax treaty. The Justice Department emphasizes that the nondiscrimination provision of the treaty only prohibits discrimination that is conditioned on the nationality of the taxpayer's parent or owners. The DOJ further asserts that the availability of look-through treatment under the section 904(d) regime is not conditioned upon the nationality of the taxpayer's parent, but rather upon the characteristics of the royalty payor. The Justice Department also notes that classifying royalty income as passive income is not necessarily more burdensome tax treatment. Finally, in the alternative, the DOJ argues that even if the section 904(d) rules conflict with the income tax treaty, the section 904(d) regime overrides the treaty.

[1] On September 30, 1998, the Commissioner of Internal Revenue issued notices of deficiency to American Air Liquide, Inc. and its subsidiaries (taxpayer), determining deficiencies in federal income tax for 1989, 1990 and 1991. (ER 11, 35.) ¹ On December 23, 1998, taxpayer filed a timely petition in the United States Tax Court, challenging the Commissioner's determinations. (ER 1; see I.R.C. section 6213(a).) The Tax Court had jurisdiction pursuant to Internal Revenue Code (I.R.C.) sections 6213(a), 6214, and 7442 (26 U.S.C.).

[2] On January 23, 2001, the Tax Court entered its decision, which is a final order that disposes of all claims of the parties. (ER 111.) On April 13, 2001, taxpayer timely filed a notice of appeal. (ER 112; see I.R.C. section 7483 and Fed. R. App. P. 13(a)(1).) This Court has jurisdiction pursuant to I.R.C. section 7482.

STATEMENT OF THE ISSUE

[3] Whether the Tax Court correctly held that the royalties received by taxpayer, a U.S. corporation, from its French parent corporation were passive income, rather than general limitation income, for purposes of the foreign tax credit.

STATEMENT OF THE CASE

[4] Taxpayer petitioned the Tax Court, contesting the Commissioner's determination of income tax deficiencies for 1989, 1990 and 1991. ² (ER 1.) The parties filed motions for judgment on the pleadings, which the court deemed to be cross-motions for summary judgment. (ER 96.) On January 16, 2001, the Tax Court issued an opinion, reported at 116 T.C. 23, granting summary judgment in favor of the Commissioner. (ER 97-110.) A week later, the Tax Court entered its decision, determining that taxpayer was liable for income tax deficiencies of $320,351, $1,083,746, and $942,456 for 1989, 1990, and 1991, respectively. (ER 111.) Taxpayer now appeals. (ER 112.)

STATEMENT OF FACTS

[5] American Air Liquide, Inc. (taxpayer) is a domestic corporation that is the common parent of a group of corporations that filed consolidated returns in the years at issue. (ER 1 at paragraph 1.) Liquid Air Corporation (LAC) is a member of taxpayer's affiliated group. (ER 3 at paragraph 4.)

[6] Taxpayer's parent is a French corporation, L'Air Liquide, S.A. ("L'Air"). (ER 3 at paragraph 4.) L'Air is engaged in the business of producing, selling, and distributing industrial gases, related equipment and services, and welding products through its own operations in France and through its French and non-French subsidiaries. (ER 7at paragraph 6(G).)

[7] Under various license agreements in effect in 1989, 1990, and 1991, L'Air paid royalties to taxpayer and LAC for non-exclusive, irrevocable, and perpetual licenses to exploit outside the United States certain intellectual property developed by LAC. The royalty amounts paid by L'Air to taxpayer and LAC in 1989, 1990, and 1991 were $4,775,000, $5,000,000, and $4,800,000, respectively. (ER 6-7 at paragraph 6(D)-(F), (H).)

[8] On its 1989, 1990, and 1991 tax returns, taxpayer classified the royalties received from L'Air as "general limitation income" for foreign tax credit purposes. After examination, the Commissioner reclassified the royalties as "passive income" for foreign tax credit purposes, and issued notices of deficiency to taxpayer. (ER 1-3, 11-56.)

[9] Taxpayer contested the Commissioner's determinations in the Tax Court, arguing that characterizing the royalties as passive income violated the income tax treaty between the United States and France (U.S.-France Treaty). ³ In addition, taxpayer argued that a reserved paragraph in the Treasury regulations mandated that the royalties be characterized as general limitation income, and that Treasury officials had stated that the Department of the Treasury would shortly issue regulations categorizing such royalties as general limitation income. (ER 58-59.)

[10] The Tax Court rejected taxpayer's arguments and sustained the Commissioner's deficiency determinations. (ER 97-110.) As an initial matter, the Tax Court noted that the Department of the Treasury recently had published a proposed regulation which would prospectively amend the existing rules to treat royalties such as those at issue as general limitation income, and that the supplementary information accompanying the proposed regulation strongly supported the Commissioner's position that the royalties received by taxpayer in 1989-1991 were passive income. (Id. at 105- 106.) The Tax Court held that classifying the royalties as passive income did not violate the U.S.-France Treaty because taxpayer had received equal treatment with all other similarly situated U.S. taxpayers. (Id. at 106-108.) It further held that the reserved paragraph on which taxpayer relied was simply a place mark in the regulations reserved to preserve continuity of codification where the Department of the Treasury was considering its position, and that the statements by Treasury officials simply confirmed that the Department was considering its position. (Id. at 108-110.) Accordingly, the Tax Court granted summary judgment in favor of the Commissioner. (Id. at 110.)

[11] Taxpayer now appeals.

SUMMARY OF ARGUMENT

[12] The Internal Revenue Code generally taxes U.S. taxpayers on income from both foreign and domestic sources. Taxation of foreign source income, however, creates the possibility that a taxpayer will be taxed by both the United States and a foreign country on the same income. To relieve such double taxation, the Code allows taxpayers to credit their foreign income taxes against their U.S. income tax liability. Congress, however, has limited the foreign tax credit to the amount of tax on foreign source income which would have been due at U.S. rates to ensure that high foreign taxes are not used to eliminate U.S. tax on domestic income. In 1986, Congress enacted I.R.C. section 904(d), which requires the foreign tax credit limitation to be calculated separately for various categories of foreign income. By segregating a taxpayer's foreign income and taxes into "baskets," the separate limitation rules are designed to prevent "averaging" of foreign tax rates applied to different categories of foreign income. Royalties are generally classified as passive income under the section 904(d) rules, but they may fall in another limitation basket if an exception applies. The Tax Court in this case correctly held that the royalties received by taxpayer from its French parent were "passive income" for foreign tax credit limitation purposes, and rejected taxpayer's contention that those royalties should instead be classified as "general limitation income." The active business exception provides that royalties which are derived in the active conduct of a trade or business and which are received from an unrelated person may be classified as general limitation income. Because taxpayer received the royalties at issue from its parent, those royalties were not received from an unrelated person, and the active business exception does not apply. Taxpayer's reliance on a proposed regulation which would prospectively amend the active business exception to include royalties received from related as well as unrelated persons is misplaced because the proposed regulation has not become finalized and, moreover, specifically provides that it would apply only prospectively.

[13] In addition to the active business exception, Congress provided a look-through exception under which royalties received by a U.S. shareholder from a controlled foreign corporation (CFC) may be classified in a separate limitation category other than passive income. Under the look-through exception, a taxpayer classifies its royalty income by reference to the category of income against which the payor allocated the royalty expenses. For example, if the payor used the property for which it paid the royalties to generate general limitation income, the taxpayer would classify those royalties as general limitation income. The application of the look-through rules therefore requires that the payee and the Commissioner have the ability to obtain income and tax information from the royalty payor.

[14] When it enacted the look-through exception, Congress noted that the exception's primary purpose was to promote parity in the treatment of income earned through foreign branches and foreign subsidiaries. Congress explicitly declined to extend look-through treatment to payments received from non-controlled foreign corporations for two reasons. First, it recognized that in such situations, obtaining the information necessary to apply the look- through rules could be difficult. Second, it noted that the purpose of promoting branch-subsidiary parity would not be served since a non-controlled foreign corporation did not substantially resemble a branch operation of U.S. persons. In other words, look-through treatment is designed for situations where the income of both the payor and payee corporations is subject to U.S. tax. In such cases, the information required to apply the look-through rules is readily available, and look-through treatment ensures that related parties receive similar U.S. tax treatment on similar items of income.

[15] Congress expressly directed the Secretary of the Treasury to issue regulations "as may be necessary or appropriate" for implementing the section 904(d) rules. Pursuant to this authority, the IRS has issued regulations extending look-through treatment to royalty payments from a U.S. corporation to a related corporation, from a U.S.-controlled partnership to a partner, and from a CFC or other look-through entity to a related look-through entity. Look- through treatment is appropriate in these circumstances because in each case, the payor's income is subject to U.S. tax. Consistent with Congress's mandate, the IRS declined to extend look-through treatment to payments from foreign parent corporations to U.S. subsidiaries. It noted that the necessary information might not be obtainable from foreign parent corporations, and that the reasons for look-through treatment were not implicated where the payor was entirely outside the jurisdiction of the United States.

[16] Taxpayer argues that the decision not to extend the look- through exception to the royalties it received from its French parent conflicts with the nondiscrimination provision of the U.S.-France Treaty. That provision prohibits other or more burdensome tax treatment of a corporate taxpayer carrying on the same activities on the grounds that it is owned or controlled by residents of the other country. Contrary to taxpayer's suggestion, however, the nondiscrimination provision is not violated simply because a U.S.- owned domestic corporation is taxed differently than a foreign-owned domestic corporation. Instead, the nondiscrimination provision only prohibits different tax treatment that is conditioned on the nationality of the taxpayer's parent or owners. It is violated only where the nationality of the taxpayer's parent, and nothing else, is the decisive criterion for the taxpayer's more burdensome tax treatment.

[17] Accordingly, where different tax treatment is based on tax-relevant differences between the taxpayers, the nondiscrimination provision is not violated. The tax treatment of royalty income under the section 904(d) regime does not depend on the nationality of the taxpayer's parent, but upon the characteristics of the royalty payor. Basing the availability of look-through treatment on the attributes of the payor makes sense because it is the payor's status that determines whether the necessary information is available and whether the reasons for look-through treatment are implicated. It was the status of taxpayer's French parent as royalty payor, rather than as taxpayer's parent, that determined the treatment of those royalties under section 904(d). Specifically, it was because the royalties taxpayer received were paid by a foreign non-controlled corporation, not because taxpayer had a French parent, that look- through treatment did not apply. That the foreign non-controlled corporation happened to be taxpayer's parent is coincidental to, not determinative of, the tax treatment of the royalties under section 904(d).

[18] As the Tax Court correctly held, the section 904(d) regime does not violate the nondiscrimination provision of the U.S.-France Treaty. But, even if this Court were to conclude that the Treaty and section 904(d) rules conflict, the statutory regime would override the Treaty. Where a treaty and statute conflict, the later provision will prevail. The section 904(d) rules were enacted long after the U.S.-France Treaty and, therefore, to the extent they conflict with the Treaty, are controlling. Furthermore, Congress expressly mandated in a 1988 revenue act that the section 904(d) rules would override any conflicting treaty provision. Accordingly, even if this Court were to conclude that the section 904(d) regime conflicts with the U.S.-France Treaty, the section 904(d) regime must prevail.

[19] The decision of the Tax Court should be affirmed.

ARGUMENT

A. INTRODUCTION

1. THE FOREIGN TAX CREDIT LIMITATIONS

[21] The Internal Revenue Code generally taxes income received by United States taxpayers from both foreign and domestic sources. See I.R.C. section 61(a) ("gross income means all income from whatever source derived"). Taxation of foreign source income, however, creates the possibility that taxpayers will be taxed twice on the same income, once by a foreign government and again by the United States. To relieve such double taxation, the Code permits taxpayers to claim a credit against their federal income tax liability for income taxes paid to a foreign country. I.R.C. section 901(a), (b), Addendum, infra; American Chicle Co. v. United States, 316 U.S. 450, 451 (1942) (foreign tax credit intended "to obviate double taxation").

[22] Since 1921, however, Congress has imposed limitations on the foreign tax credit in order to ensure that it is not used to eliminate U.S. tax on domestic source income. See generally II J. Isenbergh, International Taxation, paragraphs 27.4-27.5 (2d ed. 1996). Permitting the foreign tax credit to reduce U.S. tax on domestic income would effectively give foreign countries the primary right to tax income earned in the United States. S. Rep. No. 99-313, 1, 295 (1986), reprinted in 1986-3 C.B. (Vol. 3) at 295. The foreign tax credit limitation, which is codified at I.R.C. section 904(a), Addendum, infra, prevents high foreign taxes from offsetting federal taxes on U.S. income by limiting the amount of the credit to the amount of tax on foreign income which would have been due at U.S. tax rates. 12 J. Mertens, Law of Federal Income Taxation section 45D:58 (1991). Specifically, section 904(a) provides that the total amount of the foreign tax credit shall not exceed the proportion of U.S. tax that the taxpayer's foreign source taxable income bears to its entire taxable income. ⁴ In other words, the lower the amount of foreign source income, the lower is the amount of the foreign tax credit. The unused foreign taxes that exceed the credit limitation may be carried over and applied in other years. I.R.C. section 904(c).

[23] In the Tax Reform Act of 1986, Congress made substantial revisions to the foreign tax credit rules and enacted I.R.C. section 904(d), Addendum, infra, which provides that the foreign tax credit limitation must be calculated separately for various categories of foreign source income. Pub. L. No. 99-514, section 1201, 100 Stat. 2085, 2520. Prior to the separate limitation rules, a taxpayer could "average" foreign tax rates applied to different types of income. See S. Rep. No. 99-313, at 296, reprinted in 1986-3 C.B. (Vol. 3) at 296. Thus, for example, a taxpayer could use the high foreign taxes paid on its manufacturing income to reduce the U.S. tax on its passive income that was lightly taxed abroad. By segregating a taxpayer's foreign source income and foreign taxes into "baskets," the separate limitation rules of section 904(d) are designed to prevent such averaging of different categories of foreign income and taxes. Id. at 297, reprinted in 1986-3 C.B. (Vol. 3) at 297. As explained in the Senate Report accompanying the legislation, "[s]eparate limitations help to preserve the U.S. tax on foreign income that frequently bears little or no foreign tax while at the same time ensuring that double taxation is relieved with respect to all categories of income." Id.

[24] The separate categories of income are listed in section 904(d)(1)(A)-(I), Addendum, infra. At issue here is whether royalties received by taxpayer from its French parent fall into the "passive income" basket of section 904(d)(1)(A) or the "general limitation income" basket of section 904(d)(1)(I). General limitation income is "income other than income described in any of the preceding subparagraphs [of section 904(d)(1)]," and thus is the catch-all category for income that does not fall within any of the other separate limitation baskets. I.R.C. section 904(d)(1)(I).

[25] Passive income includes "any income received or accrued by any person which is of a kind which would be foreign personal holding company income (as defined in section 954(c))." I.R.C. section 904(d)(2)(A)(i). Foreign personal holding company income, as defined in section 954(c), Addendum, infra, includes "dividends, interest, royalties, rents, and annuities." I.R.C. section 954(c)(1)(A). Thus, as a general rule, royalties are passive income for foreign tax credit limitation purposes. Passive basket treatment preserves the residual U.S. tax on foreign source royalty income, which is generally lightly-taxed abroad. For instance, Article 11, paragraph (2) of the U.S.-France Treaty, Addendum, infra, reduces the French rate of withholding tax on royalties such as those received by the taxpayer to five percent. See T.I.A.S. 6518, reprinted in 1968-2 C.B. at 696.

[26] Royalties, however, may fall in another limitation basket if an exception to the general rule applies. Two exceptions are pertinent here, the "active business" exception and the "look- through" exception. As discussed below, the active business exception applies to certain royalties received from unrelated parties, while the look-through exception applies to royalty payments from certain related parties. ⁵

2. THE ACTIVE BUSINESS EXCEPTION

[27] As noted above, passive income is defined for foreign tax credit purposes as income "which would be foreign personal holding company income (as defined in section 954(c))." I.R.C. section 904(d)(2)(A)(i). Accordingly, royalties that are excepted from the definition of foreign personal holding company income in section 954(c) are not passive income under section 904(d).

[28] Section 954(c)(2)(A) provides that foreign personal holding company income does not include royalties "which are derived in the active conduct of a trade or business and which are received from a person other than a related person (within the meaning of subsection (d)(3))." The active business exception thus has two requirements; first, the royalties must be derived in the active conduct of a trade or business, and second, they must be received from an unrelated person. For purposes of the exception, a corporation that controls the taxpayer corporation (through direct or indirect ownership of a majority (by vote or value) of the taxpayer corporation's stock) is a related person. I.R.C. section 954(d)(3), Addendum, infra.

[29] Treasury Regulation section 1.904-4(b)(2), Addendum, infra, incorporates the active business exception for purposes of the foreign tax credit limitation rules. It provides that passive income under section 904(d) does not include any royalties "that are derived in the active conduct of a trade or business and received from a person who is an unrelated person." Treas. Reg. section 1.904- 4(b)(2)(i). An "unrelated person" is defined by reference to section 954(d)(3). Treas. Reg. section 1.904-4(b)(2)(iii).

[30] Here, taxpayer received the royalties in question from its parent corporation. Therefore, as taxpayer concedes (Br. 24), the royalties were not received from an unrelated person, and the active business exception does not apply.

[31] Taxpayer notes (Br. 24), however, that on January 3, 2001, the Commissioner issued a proposed regulation that would prospectively amend the active business exception to apply to royalties received from related as well as unrelated persons. Prop. Treas. Reg. section 1.904-4(b)(2)(i), 66 Fed. Reg. 319, 320, 327 (2001), Addendum, infra. The proposed regulation specifically states that it would apply only prospectively, to royalties paid "more than 60 days after the date these regulations are published as final regulations in the Federal Register." 66 Fed. Reg. at 327. The prospective nature of the proposed regulation is also emphasized in the Department of the Treasury's explanation of the provision. 66 Fed. Reg. at 320. Thus, even if Prop. Treas. Reg. section 1.904- 4(b)(2)(i) were to be made final, it would not apply to the royalties at issue here.

[32] Taxpayer nevertheless suggests (Br. 26-27) that this Court may wish to defer consideration of this appeal until the proposed regulation is finalized, and argues (Br. 24-26) that the Commissioner lacks the discretion to make the proposed regulation prospective. This argument lacks merit. Section 7805(b), as in effect for Code provisions enacted before July 30, 1996, grants the Commissioner authority to make regulations prospectively effective. It provides (I.R.C. section 7805(b)):

The Secretary may prescribe the extent, if any, to which any

[34] The decision to make Prop. Treas. Reg. section 1.904- 4(b)(2)(i) prospective is not only within the Commissioner's discretion, but it is entirely appropriate here. The rationale for applying regulations retroactively is that "administrative rulings were viewed as merely declaring what the statute had meant all along." Wisconsin Nipple & Fabricating Corp. v. Commissioner, 581 F.2d 1235, 1237 (7th Cir. 1978). Here, however, the amendment to the active business exception was not proposed because of a determination that the present regulations represented an incorrect interpretation of the statute; indeed, section 904(d)(2)(A)(i), which expressly incorporates section 954(c), clearly extends the active business exception only to royalties from unrelated parties. Rather, the regulatory expansion of the active business exception was proposed because a policy decision was made to extend the exception for purposes of section 904(d) to payments from related as well as unrelated parties.

[35] Furthermore, the regulatory amendment was proposed after the current rules had been in effect for nearly thirteen years. See T.D. 8214, 1988-2 C.B. 220, 226. Making the proposed amendment prospective therefore complies with the general rule that regulations which change settled law are not to be applied retroactively, see Redhouse, 728 F.2d at 1251, and leaves undisturbed transactions consummated and returns filed based on the current regulations.

[36] In short, the Commissioner's decision that the proposed regulation, if finalized, would apply only prospectively was a reasonable and appropriate exercise of his discretion. ⁶ Accordingly, taxpayer's argument is without merit.

3. THE LOOK-THROUGH EXCEPTION

[37] When it enacted the separate limitation rules, Congress provided a "look-through" exception under which royalties received by a U.S. shareholder from a controlled foreign corporation (CFC) may be classified in a basket other than passive income. I.R.C. section 904(d)(3). A CFC is a foreign corporation which is more than 50% owned (by vote or value) by U.S. shareholders, each of whom owns at least 10% of the total voting power. I.R.C. sections 904(d)(4), 951(b), 957(a), Addendum, infra; Treas. Reg. section 1.904-5(a)(2), (3), Addendum, infra. In simplest terms, a CFC is a foreign corporation that is controlled by 10% U.S. shareholders.

[38] The look-through exception of I.R.C. section 904(d)(3)(C) provides:

Any interest, rent, or royalty which is received or accrued from

[40] The primary purpose of the look-through exception is to promote parity in the treatment of income earned by a domestic corporation through foreign branches and through foreign subsidiaries. This purpose is accomplished by effectively treating income earned by a foreign subsidiary as if it were earned directly by its U.S. parent. H.R. Conf. Rep. No. 99-841, at II-573 (1986), reprinted in 1986-3 C.B. (Vol. 4) 1, 573; S. Rep. No. 99-313, at 314, reprinted in 1986-3 C.B. (Vol. 3) at 314. Branch-subsidiary parity allows taxpayers to choose more freely between the two forms of operation, and it prevents them from trying to use a branch or subsidiary form inappropriately to change the separate limitation category of income.

[41] In addition, the look-through exception promotes parity in the treatment of royalties and dividends paid by controlled entities. S. Rep. No. 99-313, at 314. Although royalty payments generally are deductible under foreign tax laws, dividend payments are not. Id. Thus, royalties reduce foreign taxes (and the resulting foreign tax credits) more than dividends, and thereby result in greater residual U.S. tax. Id. By extending the look-through treatment applicable to dividends to royalties (and rent and interest payments), Congress intended to ensure that dividends would not be favored over royalties (and other payment forms) as a means of removing earnings from a CFC. Id.

[42] Congress explicitly declined to extend look-through treatment to payments received from non-controlled foreign corporations. H.R. Conf. Rep. No. 99-841, at II-573. It recognized that shareholders in minority U.S.-owned corporations might have difficulty obtaining the income and tax information necessary to apply the look-through rules. Id. It further noted that the primary purpose of look-through treatment, i.e., promoting branch-subsidiary parity, would not be served when the U.S. interest in a foreign entity was less than a majority interest because the entity would no longer substantially resemble a branch operation of U.S. persons. ⁷ Id.

[43] Thus, the legislative history and policy goals behind the look-through exception make clear that look-through treatment was designed for situations where the income of both the payor and payee corporations is within U.S. taxing jurisdiction. In such cases, the income and tax information necessary for application of the look- through rules may be readily obtained from the payor, and look- through treatment is appropriate to ensure that income of a controlled group receives similar U.S. tax treatment regardless of which entity earns the income.

4. REGULATORY EXPANSIONS OF LOOK-THROUGH TREATMENT

[44] When Congress enacted the look-through exception, it explicitly directed the Secretary of the Treasury to prescribe regulations implementing the exception. I.R.C. section 904(d)(3)(C). Congress also instructed the Secretary to issue "such regulations as may be necessary or appropriate" for purposes of the separate limitation rules, including regulations providing that rules similar to the look-through rules apply to royalty, rent, and interest payments received from entities "which would be controlled foreign corporations if they were foreign corporations." I.R.C. section 904(d)(5)(C). ⁸

[45] Pursuant to these instructions, the IRS has issued regulations extending look-through treatment to royalty (and rent and interest) payments from a U.S. corporation to a related corporation, ⁹ from a partnership to a partner (with certain exceptions), and from a CFC (or other look-through entity) to a related look-through entity. See Treas. Reg. sections 1.904-5(g), (h), and (i), Addendum, infra. Look-through treatment is appropriate in these situations because, in each case, the payor's income is subject to U.S. tax, and therefore the income information necessary to verify the character of the payment is obtainable by the Commissioner. ¹⁰ Specifically, a U.S. corporation is subject to U.S. tax, see I.R.C. section 11, the income of a partnership is taxed by the United States in its U.S. partners' hands, see I.R.C. section 702, and the income of a CFC is taxable to its U.S. shareholders, see I.R.C. section 951.

[46] Consistent with Congress's determination that look-through treatment should not be extended to non-controlled foreign corporations, see H.R. Conf. Rep. No. 99-841, at II-573, the IRS declined to extend look-through treatment to payments from foreign parent corporations to U.S. subsidiaries, see T.D. 8412, 1992-1 C.B. at 273. The IRS explained that it might not be able to obtain all of the necessary information concerning the foreign parent corporation's income and expenses and to audit it. Id. The IRS further noted that the income of the foreign parent corporation was not subject to U.S. tax, and thus the reasons for look-through treatment were not implicated. Id. Specifically, it stated that "the payments generally would be deductible from taxable income of the payor that is entirely outside the jurisdiction of the United States (including subpart F) and, therefore, do not give rise to the same concerns involved in other look-through cases." Id.

[47] The IRS reiterated its determination that look-through treatment is inappropriate for payments from a foreign parent corporation to its U.S. subsidiary earlier this year. The explanation accompanying Prop. Treas. Reg. section 1.904-4(b)(2), which was published on January 3, 2001 and is discussed supra pp. 16-18, notes that "Treasury and the IRS have consistently declined to extend look- through treatment to payments from foreign non-controlled payors." 66 Fed. Reg. at 320. It further states (id.):

Treasury and the IRS continue to believe that the nature of the

[49] On appeal, taxpayer does not dispute that the regulations do not provide look-through treatment for the royalties it received from its French parent. ¹¹ Instead, taxpayer argues (Br. 27-47) that the Commissioner's decision not to extend the look-through exception to those royalties conflicts with the U.S.-France Treaty. As shown below, the Tax Court correctly rejected taxpayer's argument.

B. CLASSIFYING THE ROYALTIES PAID TO TAXPAYER BY ITS FOREIGN

[51] The treaty provision at issue in this case, Article 24, paragraph (3) of the U.S.-France Treaty, is a nondiscrimination provision prohibiting "other or more burdensome" tax treatment of a corporate taxpayer on the grounds that it is owned or controlled by residents of the other country. It states as follows (T.I.A.S. 6518, reprinted in 1968-2 C.B. at 701):

A corporation of a Contracting State, the capital of which is

[53] Taxpayer's argument relies on an overly simplistic construction of the nondiscrimination provision of the U.S.-France Treaty, viz., that it is violated wherever a U.S.-owned domestic corporation is taxed differently than a foreign-owned domestic corporation. But the nondiscrimination provision is not a sweeping prohibition on any differences in tax treatment of U.S.-owned and foreign-owned domestic corporations; rather, it forbids different tax treatment of such corporations only where the difference is CONDITIONED on the domestic or foreign status of the owner of the taxpayer corporation. The nondiscrimination provision is violated "only where nationality -- and nothing else -- is the DECISIVE CRITERION for the taxpayer's being treated less favourably under domestic tax law." Klaus Vogel, Klaus Vogel on Double Taxation Conventions: A Commentary to the OECD-, UN-, and US Model Conventions for the Avoidance of Double Taxation of Income and Capital, 1290 (3d ed. 1997) (construing the comparable nondiscrimination provisions of the OECD, UN, and US Model Conventions) (emphasis in original). Where foreign-owned taxpayers are "treated less favourably for other reasons than nationality (more precisely: if the decisive legal factor is a CRITERION OTHER than their nationality) there is no case of a violation." Id. (emphasis in original).

[54] The Treasury Department Technical Explanation of the analogous nondiscrimination provision of the 1996 U.S. Model Convention also emphasizes that the nondiscrimination provision prohibits only different tax treatment which is based solely on the nationality of the taxpayer's parent. Treasury Department Technical Explanation of the United States Model Income Tax Convention (September 20, 1996), Tax Treaties (CCH), paragraph 214A at 10,633-41 (hereinafter "Technical Explanation"). The Technical Explanation expressly states that not all differences in tax treatment violate the nondiscrimination provision. Id. at 10,633-41 - 10,633-42. It explains that the nondiscrimination provision applies only if the foreign-owned and domestic-owned corporations are comparably situated, and that corporations are not similarly situated if there is a tax-relevant difference in their situations. Specifically, it provides that whether the language refers to entities "in the same circumstances," "carrying on the same activities," or that are "similar," "the common underlying premise is that if the difference in treatment is directly related to a tax-relevant difference in the situations of the domestic and foreign persons being compared, that difference is not to be treated as discriminatory." Id. at 10,633-42. By way of example, the Technical Explanation notes that different tax treatment would be justified where one person was taxable on worldwide income but the other was not, or if tax could be collected from one person at a later stage but not from the other. Id. at 10,633-42.

[55] Another example of tax-relevant differences is set forth in the Senate Report accompanying the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-647, 102 Stat. 3342. See S. Rep. No. 100-445, at 320, reprinted in 1988 U.S.C.C.A.N. at 4831. In addressing a provision concerning conflicts between tax statutes and tax treaties, the Senate Report explains that taxing the liquidating distributions of foreign-owned U.S. corporations, but not of U.S.- owned U.S. corporations, does not violate the nondiscrimation rule because "a U.S. enterprise transferring assets to a shareholder who will bear U.S. corporate level tax on the income generated by those assets is not similar to a U.S. enterprise transferring assets to a shareholder who will not bear U.S. corporate level tax on the income generated by those assets." Id. at 4832. In other words, the different tax treatment of liquidating distributions of U.S.-owned and foreign-owned domestic corporations is not discriminatory because it is based on a tax-relevant difference between the corporations, i.e., whether the corporation's owner is subject to U.S. tax.

[56] The Technical Explanation also notes that the different tax treatment of liquidating distributions of foreign-owned and U.S.- owned domestic corporations does not violate the nondiscrimination provision. Technical Explanation, at 10,633-45. It states that the different tax treatment "is based not upon the nationality of the owners of the distributing corporation, but rather is based upon whether such owners would be subject to corporate tax if they subsequently sold or distributed the same property." Id.

[57] Similarly, the Technical Explanation notes that it is not discriminatory to bar U.S. corporations with nonresident alien shareholders from electing "S" corporation status because the rule is based on tax-relevant differences. Technical Explanation, at 10,633- 45. It explains that the S corporation provisions do not exclude corporations with nonresident alien shareholders because those shareholders are foreign, but because they do not pay U.S. tax on a net basis. Id.

[58] These examples make clear that impermissible discrimination occurs only if foreign-owned U.S. corporations are treated differently because of their foreign ownership, and for no other reason. This point is confirmed by the Tax Court's recent opinion in Unionbancal Corp. v. Commissioner, 113 T.C. 309 (1999), which is currently on appeal to this Court, No. 00-70764. In Unionbancal, the taxpayer, a U.S. corporation, sold a loan portfolio at a loss to its parent, a United Kingdom corporation. 113 T.C. at 310-311. Under I.R.C. section 267 and accompanying temporary regulations, the taxpayer was subject to a permanent loss disallowance, but the purchasing parent was allowed to increase its basis in the loan portfolio. Id. at 313-315. U.K. law, however, did not permit taxpayer's U.K. parent to adjust its basis in the loan portfolio. Id. at 313. The taxpayer challenged the validity of the regulations, and also claimed that they violated the nondiscrimination provision of the U.S.-U.K. tax treaty because they resulted in different tax treatment for a U.K.-owned U.S. corporation than for a U.S.-owned U.S. corporation. Specifically, if the sale had been from a U.S. subsidiary to its U.S. parent, the U.S. parent would have been entitled to increase its basis in the property, whereas taxpayer's corporate group had to seek relief under the U.S. and U.K. competent authority procedures. Id. at 326.

[59] The Tax Court upheld the validity of the regulations, and rejected taxpayer's claim of discrimination. Unionbancal, 113 T.C. at 318-326. It held that the treaty's nondiscrimination provision was not violated by the different tax treatment of U.K.-owned and U.S.- owned domestic corporations because that different treatment was not "conditioned on" the nationality of the taxpayer's parent, but instead depended on the particular activities of the taxpayer. Id. at 326. It observed (id.):

The operation of neither section 267(f) nor the Temporary

[61] Taxpayer further claims (Br. 43) that, unlike Unionbancal, the regulations at issue here grant or deny look-through treatment depending on whether taxpayer is U.S.-owned or foreign-owned. This contention is incorrect. As discussed below, the application of look- through treatment under the section 904(d) rules depends on the characteristics of the royalty payor, not on the nationality of the taxpayer's parent. Accordingly, like the statutory and regulatory regime at issue in Unionbancal, 113 T.C. at 326, the section 904(d) rules are not conditioned on the country of incorporation of the taxpayer's parent. The section 904(d) regime therefore does not violate the nondiscrimination provision of the U.S.-France Treaty.

2. THE AVAILABILITY OF LOOK-THROUGH TREATMENT UNDER THE

[63] As this review of the rules for classifying royalty income shows, the tax treatment of royalty payments under the section 904(d) regime depends on the attributes of the payor of the royalties, such as whether the payor is related to taxpayer, whether the payor is domestic or foreign, whether the payor is a corporation or partnership, etc. The availability of look-through treatment is based on the characteristics of the payor because, as noted above, it is the characteristics of the payor that determine whether the information needed to apply the look-through rules will be obtainable and whether the policy concerns behind look-through treatment are implicated. See H.R. Conf. Rep. No. 99-841, at II-573; T.D. 8412, 1992-1 C.B. at 273.

[64] Thus, as in Unionbancal, 113 T.C. at 326, the statutory and regulatory regime at issue here is not conditioned solely on the nationality of the taxpayer's parent. Instead, look-through treatment depends on the attributes of the payor, without regard to whether the taxpayer's parent is foreign or domestic. Accordingly, the section 904(d) regime does not conflict with the nondiscrimination provision of the U.S.-France Treaty. Unionbancal, 113 T.C. at 326.

[65] Taxpayer nevertheless contends (Br. 27) that the section 904(d) rules violate the Treaty because they deny look-through treatment to the royalties it received from its French parent, but would allow look-through treatment for royalties received by a U.S. subsidiary from a U.S. parent. Taxpayer's argument, however, erroneously conflates the dual roles of its French parent in this case as the royalty payor and as taxpayer's parent. It was not because taxpayer had a French parent that look-through treatment did not apply, but because the royalties were paid by a foreign non- controlled corporation. That the foreign non-controlled corporation happened to be taxpayer's parent is coincidental to, not determinative of, the tax treatment of the royalties under section 904(d). In other words, it is L'Air's role as royalty payor, not as taxpayer's parent, that dictated the treatment of the royalties under section 904(d).

[66] When this distinction between L'Air's role as payor and as parent is properly understood, it is clear that taxpayer is eligible for look-through treatment on the same terms that apply to domestic corporations with U.S. parents. For example, regardless of its French ownership, taxpayer would be entitled to look-through treatment for foreign-source royalties received from a CFC, see I.R.C. section 904(d)(3)(C), or from a related U.S. subsidiary of its French parent, see Treas. Reg. section 1.904-5(g). ¹³ Similarly, regardless of its U.S. ownership, a domestic corporation with a U.S. parent that received royalties from a non-controlled foreign corporation would, like taxpayer, not qualify for look-through treatment. See H.R. Conf. Rep. No. 99-841, at II-573 (declining to extend look-through treatment to royalties from non-controlled foreign corporations); T.D. 8412, 1992-1 C.B. at 273 (same).

[67] The Tax Court therefore correctly held (ER 108) that the treatment of taxpayer's royalty income "is determined in exactly the same manner as for any other domestic corporation receiving royalty income from a noncontrolled foreign corporation." Taxpayer claims (Br. 37-38) that the Tax Court erred in this determination because it did not explicitly restrict its comparison to royalties received from related corporations. This contention is misconceived. Because it is the non-controlled foreign corporation status of L'Air, rather than its related status, that is determinative of the unavailability of look-through treatment here, the Tax Court appropriately compared taxpayer to a U.S.-owned corporation receiving royalties from a non- controlled foreign corporation. Since a U.S.-owned corporation receiving royalties from a non-controlled foreign corporation (related or not) would not qualify for look-through treatment, taxpayer has, as the Tax Court concluded, "received equal treatment with all other similarly situated taxpayers residing in the United States." (ER 108.)

[68] Taxpayer nevertheless attempts to prove its claim of discrimination by comparing (Br. 20-21, 28-29) the tax treatment of royalties where both the recipient and payor are controlled by U.S. interests to that where both the recipient and payor are controlled by foreign interests. But this comparison is misleading. It improperly confuses the question whether the royalty PAYOR is a U.S. or U.S.-controlled corporation -- which is the determinative factor for look-through treatment under the section 904(d) rules -- with whether the RECIPIENT is U.S. or foreign-owned -- which is immaterial for purposes of determining whether look-through treatment applies. Contrary to taxpayer's suggestion, in each of its examples, it is the fact that the PAYOR, not the recipient, is a U.S. or U.S.-controlled corporation that affects the applicability of the look-through rules.

[69] That the look-through rules result in different tax treatment for royalties received by a domestic corporation from its foreign parent than for royalties received by a domestic corporation from its U.S. parent does not violate the nondiscrimination provision of the U.S.-France Treaty. As discussed above, the nondiscrimination provision prohibits only different tax treatment of foreign-owned and U.S.-owned corporations that are comparably situated, and corporations are not comparably situated if there is a tax-relevant difference in their situations. See, e.g., Technical Explanation, at 10,633-41; Vogel, supra, 1290. In other words, U.S.-owned and foreign-owned domestic corporations are not "carrying on the same activities" within the meaning of the Treaty if their activities involve a tax-relevant difference.

[70] There is a tax-relevant difference between a domestic corporation that receives royalties from a U.S. parent and a domestic corporation that receives royalties from a French parent. In the former case, the taxpayer is receiving income from a payor that is subject to U.S. tax, whereas in the latter case, the taxpayer is receiving income from a payor that is not subject to U.S. tax. ¹⁴ As noted above, Congress and the Treasury Department have both made it clear in discussing the tax treatment of liquidating distributions that whether a taxpayer's parent is subject to U.S. tax constitutes a tax-relevant difference justifying different tax treatment of U.S. and foreign-owned domestic corporations. See S. Rep. No. 100-445, at 320; Technical Explanation, at 10,633-45. Because the different tax treatment of royalties received from a U.S. parent and a French parent is based on whether the parent, in its role as payor, is subject to U.S. tax, rather than simply on whether the parent, in its role as parent, is foreign or domestic, that different tax treatment does not violate the nondiscrimination provision of the U.S.-France Treaty. ¹⁵

3. CLASSIFYING ROYALTY INCOME AS PASSIVE INCOME IS NOT

[72] Passive income treatment is not always different than the result under the look-through rules or more burdensome than general limitation treatment. As discussed above, where applicable, the look- through rules generally classify a taxpayer's royalty income based on the income category to which the payor allocated its royalty expenses. See I.R.C. section 904(d)(3)(C); Treas. Reg. section 1.904- 5. Therefore, if the payor used the licensed property to generate passive income, the look-through rules require the taxpayer to treat the royalty payments as passive income. Application of the look- through rules thus can yield the same result as placing the income in the passive basket.

[73] Look-through treatment can also yield a less favorable result for a particular taxpayer than passive income treatment. For instance, if the payor used the licensed property to earn income in a certain category, and the taxpayer had no excess foreign tax credits in that category, but did have excess foreign taxes in the same passive subgroup, look-through treatment would be more burdensome than passive income treatment. See Treas. Reg. section 1.904-4(c)(3) (providing grouping rules for applying the high-taxed exception of section 904(d)(2)(A)(iii)(III)). Similarly, whether passive income treatment is more or less favorable than general limitation income treatment depends on the particular taxpayer and the other items of income and foreign taxes in its separate limitation categories. If the taxpayer had no excess foreign taxes in its general limitation category (which would occur whenever the taxpayer's general limitation income was subject to foreign tax at less than the U.S. rate), passive income treatment would be at least as favorable as general limitation income treatment. Accordingly, taxpayer's suggestion that the denial of look-through treatment and classification of royalties as passive, rather than general limitation, income is always more burdensome is inaccurate. ¹⁶

[74] Furthermore, contrary to taxpayer's assertion (Br. 40), it has not been established that, if the look-through rules were applied in this case, the royalties at issue would be classified as general limitation income. Rather, the Commissioner accepted, as true, taxpayer's allegation that the royalties it received from its French parent would be general limitation income (see ER 7-9) only for purposes of its motion for judgment on the pleadings (see Doc. 8 at 2; Doc. 17 at 2). Therefore, if this Court were to determine that look-through treatment applies to the royalties in question, a remand would be necessary to determine what category of income the royalties would be allocable to on the yet-to-be-constructed U.S. tax books of taxpayer's French parent. In other words, taxpayer would have to produce L'Air's income and tax information, which is required to apply the look-through rules, and prove that L'Air allocated the royalty expenses to general limitation income.

4. TAXPAYER'S RELIANCE ON FOREIGN CASES IS UNAVAILING

[75] Taxpayer cites (Br. 44-47) three summaries of decisions in which foreign courts addressed nondiscrimination provisions of treaties between Sweden and the Netherlands, the United States and the Netherlands, and Japan and the Netherlands, respectively, and claims that these decisions show that it was subjected to impermissible discrimination under the U.S.-France Treaty. Taxpayer's reliance on these summarized decisions, however, is misplaced.

[76] It has long been established that a foreign judgment has no force beyond the limits of the sovereignty from which its authority is derived. See, e.g., Hilton v. Guyot, 159 U.S. 113, 163 (1895); Wilson v. Marchington, 127 F.3d 805, 807 (9th Cir. 1997). Accordingly, the decisions of foreign courts are not binding on U.S. courts, and the decisions that taxpayer cites are without precedential value. See Bird v. Glacier Elec. Coop., Inc., 255 F.3d 1136, 1140 (9th Cir. 2001) ("the decision to recognize a foreign judgment is discretionary, not mandatory").

[77] In any event, the summarized decisions do not support taxpayer's discrimination claim. Taxpayer states (Br. 47) that the foreign decisions found discrimination where different tax treatment was accorded to foreign-owned and domestic-owned domestic corporations "engaged in the SAME TRANSACTION." (Emphasis in original.) As discussed above, a domestic corporation receiving royalties from a U.S. parent and a domestic corporation receiving royalties from a foreign parent are not engaged in the same transaction. Rather, one corporation is licensing property to an entity that is subject to U.S. tax, while the other is licensing property to an entity that is outside the jurisdiction of the United States. The corporations thus are not carrying on the same activities for federal income tax purposes. See S. Rep. No. 100-445, at 320; Technical Explanation, at 10,633-45.

[78] Here, taxpayer is engaged in the same transaction as a U.S.-owned domestic corporation receiving royalties from a non- controlled foreign corporation. Because, like taxpayer, such a corporation would not qualify for look-through treatment, see H.R. Conf. Rep. No. 99-841, at II-573; T.D. 8412, 1992-1 C.B. at 273, taxpayer has received the same tax treatment as a U.S.-owned domestic corporation engaged in the same transaction. Accordingly, even under the non-binding foreign decisions that taxpayer cites, taxpayer has not suffered any discriminatory tax treatment.

C. ALTERNATIVELY, EVEN IF THE SECTION 904(d) RULES CONFLICT WITH

[80] Where a treaty and a statute cannot be interpreted consistently, "the one last in date will control the other." Whitney v. Robertson, 124 U.S. 190, 194 (1888). Therefore, if a statute is amended after a treaty is executed and the statute, as amended, conflicts with the treaty, the statute overrides the treaty. See, e.g., Reid v. Covert, 354 U.S. 1, 18 (1957); Wong Gar Wah v. Carr, 18 F.2d 250, 251 (9th Cir. 1927). Here, the U.S.-France Treaty was executed in 1967, see T.I.A.S. 6518, while the separate limitation rules of section 904(d) were added to the Code by section 1201 of the Tax Reform Act of 1986, see Pub. L. No. 99-514, section 1201, 100 Stat. 2085, 2520. Because the section 904(d) rules are later-in-time, to the extent they conflict with the U.S.-France Treaty, they prevail over the Treaty. ¹⁷

[81] Moreover, two years after enacting the separate limitation rules of section 904(d), Congress expressly mandated that those rules would override any existing treaty provisions. Specifically, in the Technical and Miscellaneous Revenue Act of 1988 ("TAMRA"), Pub. L. No. 100-647, section 1012(aa)(2), 102 Stat. 3342, 3531, Congress provided:

(2) Certain Amendments to Apply Notwithstanding Treaties. -- The

[83] Contrary to taxpayer's claim, it is section 904(d) itself, not the regulations or lack of regulations, that dictates taxpayer's tax treatment. As noted above, section 904(d)(2)(A)(i) unambiguously classifies the royalties that taxpayer received from its French parent as passive income for foreign tax credit limitation purposes. The Commissioner's decision not to alter this statutory treatment by regulation does not change the fact that the passive income treatment here directly results from a straightforward application of the statute. Thus, the later-enacted statutory treatment overrides any conflicting provision of the U.S.-France Treaty.

[84] Furthermore, the Commissioner's promulgation of Treas. Reg. section 1.904-5(g) and his decision not to extend look-through treatment to payments from foreign parents to U.S. subsidiaries is in precise accordance with the statutory scheme devised by Congress. As noted above, Congress stated that a primary purpose of granting look- through treatment under section 904(d) was to foster branch- subsidiary parity. H.R. Conf. Rep. No. 99-841, at II-573; S. Rep. No. 99-313, at 314. In extending look-through treatment to income earned through related U.S. corporations, see Treas. Reg. section 1.904- 5(g), the Commissioner simply followed the policy goals articulated by Congress.

[85] Similarly, in declining to extend look-through treatment to payments from non-controlled foreign corporations, the Commissioner again adhered to an express Congressional directive. As previously discussed, Congress specifically determined that extending look-through treatment to payments from non-controlled foreign corporations would present administrative difficulties and would not serve the purposes of the look-through rules. H.R. Conf. Rep. No. 99- 841, at II-573. Accordingly, the Commissioner's decision not to extend look-through treatment to payments from foreign parents is tailored to Congress' mandate.

[86] In short, the alleged discrimination of which taxpayer complains directly results from application of the statute itself, see I.R.C. section 904(d)(2)(A)(i), and the absence of a regulation extending look-through treatment to taxpayer is grounded in the statutory scheme articulated by Congress. Therefore, even if this Court were to conclude that the section 904(d) regime conflicts with the nondiscrimination provision of the U.S.-France Treaty, the section 904(d) regime would override the earlier-in-time Treaty.

CONCLUSION

[87] For the foregoing reasons, the decision of the Tax Court is correct and should be affirmed.

Respectfully submitted,

[88] Pursuant to Ninth Circuit Rule 28-2.6, counsel for the appellee respectfully inform the Court that they are aware of an appeal pending in this Court, Unionbancal Corp. v. Commissioner, 9th Cir. -- No. 00-70764, which addresses a treaty interpretation issue related to the issue in this case.

Certificate of Compliance Pursuant to Fed. R. App. 32(a)(7)(C) and

[89] It is hereby certified that service of the foregoing brief has been made on counsel for the Appellant, on this 4th day of September, 2001, by mailing two copies thereof in an envelope properly addressed to him as follows:

Edmund S. Cohen, Esquire

² Taxpayer agreed to some of the adjustments made by the Commissioner. The deficiencies determined by the Commissioner, and the amounts disputed and undisputed by taxpayer are as follows (ER 2 at paragraph 3):

     Year      Deficiency     Amount Disputed   Amount Not Disputed

⁴ Stated as a formula, the section 904(a) foreign tax credit limitation is computed as follows:

Maximum credit =    U.S. tax on    x    Foreign source taxable income

⁶ Indeed, the propriety of issuing regulations with prospective effect is supported by Congress' decision in 1996 to amend I.R.C. section 7805(b) to provide that regulations relating to Code provisions enacted after July 30, 1996 generally would not apply retroactively. Taxpayer Bill of Rights 2, Pub. L. No. 104-168, section 1101, 110 Stat. 1452, 1468 (1996). Congress enacted the statutory amendment because it believed "that it is generally inappropriate for Treasury to issue retroactive regulations." H.R. Rep. No. 104-506, at 44 (1996), reprinted in, 1996-3 C.B. 49, 92.

⁷ The Conference Report states (H.R. Conf. Rep. 99-841, at II- 573):

No look-through rules generally are applied in characterizing,

⁹ As originally promulgated, Treas. Reg. section 1.904-5(g) extended look-through treatment only to payments from a U.S. corporation to a related U.S. corporation. T.D. 8214, 1988-2 C.B. 220. The regulation was amended in 1992 and applied retroactively to extend look-through treatment to payments from a U.S. corporation to any related corporation. T.D. 8412, 1992-1 C.B. 271, 285.

¹⁰ In addition, where the payor and payee corporations are part of a common group of U.S. corporations filing a consolidated return, look-through treatment ensures that the income inclusion and the deduction with respect to the intercompany royalty "wash" in computing the consolidated foreign tax credit limitation.

¹¹ Before the Tax Court, taxpayer argued that a subsequently withdrawn reserved paragraph in the regulations, which was captioned "Special rule for payments from foreign parents to domestic subsidiaries" and contained no text, see Treas. Reg. section 1.904- 5(i)(3), T.D. 8214, 1988-2 C.B. 220, 239, mandated that the royalties it received from its French parent be characterized as general limitation income. In its opening brief, taxpayer cursorily notes (Br. 22), but does not advance, this argument, and it therefore has waived appellate review of the issue. See, e.g., Smith v. Marsh, 194 F.3d 1045, 1052 (9th Cir. 1999) (arguments not raised by a party in its opening brief are deemed waived); Eberle v. City of Anaheim, 901 F.2d 814, 818 (9th Cir. 1990) (same).

In any event, the argument has no merit. The Tax Court correctly noted (ER 109) that a reserved paragraph is merely a place-saver used to preserve continuity of codification where future text may be added. See Connecticut Gen. Life Ins. Co. v. Commissioner, 177 F.3d 136, 145 (3d Cir. 1999). Indeed, the reserved paragraph at issue here never contained any text, much less a special look-through rule. Furthermore, the Commissioner deleted the reserved paragraph in the final regulations issued in 1992, explaining that look-through treatment would not be extended to payments from a foreign parent due to the administrative and policy concerns discussed above. T.D. 8412, 1992-1 C.B. at 273. The Tax Court therefore correctly held (ER 108- 110) that taxpayer's reliance on the reserved paragraph was misplaced.

¹² Section 7852(d) provides:

For purposes of determining the relationship between a provision

¹⁴ Taxpayer erroneously relies (Br. 56) on G.C.M. 34000 (Dec.20, 1968) and G.C.M. 35518 (Oct. 11, 1973) to claim that the Commissioner has acknowledged that the rationale for discrimination is irrelevant. The Commissioner, however, has made no such concession, and neither G.C.M. 34000, which was withdrawn by G.C.M. 34184 (Aug. 18, 1969), nor G.C.M. 35518 support taxpayer's position. Indeed, G.C.M. 35518 clearly provides that whether taxpayers are in similar circumstances for federal income tax purposes is a relevant inquiry for determining the existence of discrimination, and it thus supports the conclusion that the existence of impermissible discrimination depends on the reason for the different tax treatment (i.e., whether it was based on tax-relevant differences). Moreover, as discussed above, Congress and the Treasury Department have both made clear that whether there are tax-relevant differences between taxpayers is relevant to determining whether discrimination exists. See S. Rep. No. 100-445, at 320, Technical Explanation, at 10,633-45.

Furthermore, taxpayer's suggestion (Br. 58) that tax policy considerations arise only in cases of "outbound transfers" is meritless. Both Congress and the Treasury Department have specifically noted that a tax-relevant difference exists between payments to a U.S. corporation from a non-controlled foreign corporation and from entities that are subject to U.S. tax, and that the policy reasons for look-through treatment are inapplicable to payments from non-controlled foreign corporations. H.R. Conf. Rep. No. 99-841, at II-573, T.D. 8412, 1992-1 C.B. at 273. It is therefore apparent that tax-relevant differences and the corresponding policy considerations also arise where, as here, the income at issue flows into the United States.

¹⁵ Indeed, because foreign parent corporations are not subject to U.S. tax, it would be difficult, if not impossible, to apply the look-through rules. As discussed above, the application of the look- through rules requires knowledge of the payor's income and tax information. Where the payor is a foreign corporation outside the jurisdiction of the United States, it is of course not required to maintain U.S. tax books organized on U.S. tax principles, nor is it obligated to produce its financial information to the IRS.

¹⁶ Taxpayer's claim (Br. 40 n.8) that the Treasury Department has conceded that passive income treatment is more burdensome is without merit. Taxpayer's sole support for this claim is one phrase, viewed in isolation, from a 1992 letter by a Treasury official to a group that had stated concerns about passive income treatment as applied to its members. This solitary phrase in a single letter from a Treasury official hardly constitutes an official legal admission by the Treasury Department about passive income treatment in general.

¹⁷ In an attempt to twist the later-in-time rule to its favor, taxpayer notes (Br. 55-56) that a new U.S.-France Treaty containing a comparable nondiscrimination provision became effective in 1996. This case, however, involves taxpayer's 1989, 1990, and 1991 tax years, and, for purposes of the later-in-time rule, it is the U.S.-France Treaty that was in effect during those years that is relevant here. Accordingly, taxpayer's reliance on the 1996 Treaty in this regard is misplaced.