SCOTUS Reports

Tag: Section 863(b)

  • Phillips Petroleum Co. v. Commissioner, 105 T.C. 486 (1995): Apportionment of Income from Cross-Border Sales of LNG

    Phillips Petroleum Co. v. Commissioner, 105 T. C. 486 (1995)

    Income from cross-border sales of personal property must be apportioned between domestic and foreign sources using specific regulatory examples when an independent factory price cannot be established.

    Summary

    Phillips Petroleum Co. sought to apportion income from the sale of liquefied natural gas (LNG) produced in Alaska and sold in Japan as partly foreign-sourced. The IRS determined that all income was domestic-sourced. The Tax Court, in a prior ruling, invalidated the IRS’s regulation and mandated apportionment under section 863(b). The key issue was whether the income should be apportioned using an independent factory price (Example 1) or a 50/50 split method (Example 2). The court held that Example 1 was inapplicable due to the absence of sales to independent distributors, and thus applied Example 2, which splits the income equally between production and sales, further apportioning each half based on property and sales location.

    Facts

    Phillips Petroleum Co. extracted natural gas from the North Cook Inlet in Alaska, liquefied it at a plant in Kenai, Alaska, and sold it to Tokyo Electric Power Co. and Tokyo Gas Co. in Japan under a long-term contract. The sales agreement stipulated delivery and title transfer in Japan. Phillips and Marathon Oil Co. formed a joint venture to fulfill the contract. Phillips engaged in extensive negotiations with Japanese buyers, involving multiple trips to Japan and assistance from its subsidiary, Phillips Petroleum International Corp. The price of LNG was renegotiated several times due to changing market conditions and political pressures.

    Procedural History

    The IRS issued a notice of deficiency to Phillips, asserting that all income from LNG sales was domestic-sourced. Phillips challenged this in the Tax Court. In a prior opinion (97 T. C. 30 (1991)), the court invalidated the IRS’s regulation under section 1. 863-1(b) and held that the income was partly foreign-sourced under section 863(b). The case returned to the court to determine the appropriate method for apportioning the income.

    Issue(s)

    1. Whether the income from Phillips’ sale of LNG to Tokyo Electric and Tokyo Gas should be apportioned under Example 1 of section 1. 863-3(b)(2), Income Tax Regs. , which requires an independent factory price?
    2. If Example 1 is inapplicable, whether the income should be apportioned under Example 2 of section 1. 863-3(b)(2), Income Tax Regs. , which uses a 50/50 split method?

    Holding

    1. No, because the sales were not made to independent distributors or selling concerns as required by Example 1, and thus an independent factory price could not be established.
    2. Yes, because Example 1 was inapplicable, the income was apportioned under Example 2, which splits the income equally between production and sales, with each half further apportioned based on the location of property and sales.

    Court’s Reasoning

    The court analyzed the regulatory framework under section 863(b) and the related regulations, focusing on the examples provided for apportioning income from cross-border sales. The court determined that Example 1 required sales to be made to independent distributors or selling concerns to establish an independent factory price, which was not the case with Tokyo Electric and Tokyo Gas, who transformed the LNG before resale. The court rejected the IRS’s broad interpretation of “distributor” and found that the buyers did not fit the traditional definition of a distributor. Consequently, the court applied Example 2, which mandates a 50/50 split of taxable income, with one half apportioned based on the location of property and the other half based on the location of sales. The court also addressed disputes over the valuation and location of certain assets used in the apportionment formula, ultimately excluding leased property and inventory in international waters from the property apportionment fraction.

    Practical Implications

    This decision clarifies the methodology for apportioning income from cross-border sales of personal property when an independent factory price cannot be established. It underscores the importance of the nature of the buyer in determining whether an independent factory price can be used. For companies engaged in similar transactions, this case provides guidance on how to structure sales agreements and manage tax implications. It also highlights the need for careful documentation and valuation of assets used in the production and sale of goods for tax purposes. The decision may influence future tax planning and negotiations in international trade, particularly in industries involving the sale of natural resources or manufactured goods across borders.

  • Estate of de Eissengarthen v. Commissioner, 10 T.C. 1277 (1948): Exclusion of Nonresident Alien’s Bank Deposits for Estate Tax Purposes

    10 T.C. 1277 (1948)

    Moneys deposited in a U.S. bank are considered deposited “for” a nonresident alien, and thus excluded from the gross estate for estate tax purposes, if the nonresident alien is the sole heir to the account and there are no known creditors.

    Summary

    This case addresses whether funds deposited in a New York bank account are includible in the gross estate of a nonresident alien for U.S. estate tax purposes. The decedent, Anna de Eissengarthen, was the sole heir to her son Jean’s estate, which included a bank account in New York. The Tax Court held that because Anna was the sole heir under Swiss law, and there were no known creditors of Jean in New York, the funds were considered to be deposited “for” Anna, a nonresident alien, and are therefore excludable from her gross estate under Section 863(b) of the Internal Revenue Code.

    Facts

    Jean Eissengarthen, a Swiss citizen and resident, had a cash deposit account with Guaranty Trust Co. in New York. Upon Jean’s death, his mother, Anna de Eissengarthen, a Chilean citizen and resident of Switzerland, became his sole heir under his will, with no executor appointed. Swiss law dictated that upon death, the decedent’s property immediately becomes the property of the heir. Anna died several months later. At the time of Anna’s death, there were no known creditors of Jean residing in New York. The funds remained in Jean’s name at the bank.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Anna’s estate tax, including the New York bank deposit in her gross estate. The estate’s ancillary administrator contested this inclusion, arguing the funds were excludable under Section 863(b). The Tax Court reviewed the Commissioner’s determination.

    Issue(s)

    Whether the funds in Jean Eissengarthen’s New York bank account were deposited “for” Anna de Eissengarthen, a nonresident alien, at the time of her death, thus qualifying for exclusion from her gross estate under Section 863(b) of the Internal Revenue Code.

    Holding

    Yes, because under Swiss law, Anna became the sole owner of the bank deposit upon Jean’s death, and there were no known creditors of Jean in New York. Therefore, the funds were considered to be on deposit for her benefit, satisfying the requirements of Section 863(b).

    Court’s Reasoning

    The Tax Court relied on the language of Section 863(b), which excludes bank deposits made “by or for” a nonresident alien not engaged in business in the United States. The court emphasized that the statute does not require the deposit to be made directly by the decedent. The court interpreted “for” to mean “for the use and benefit of” or “upon behalf of.” The court gave considerable weight to the stipulated fact that under Swiss law, Anna became the sole owner of the bank deposit immediately upon Jean’s death. The court distinguished City Bank Farmers Trust Co. v. Pedrick, noting that in that case, the trustee’s discretion over the funds prevented a clear finding that the deposit was for the decedent’s benefit. Here, because Anna was the outright owner with no known creditors, the court reasoned that the funds were unequivocally on deposit for her benefit, regardless of the bank’s requirement for ancillary administration before releasing the funds. The court stated, “These things being true, it follows, we think, that, immediately upon the death of Jean, Anna became the sole owner of the bank deposit in question and, notwithstanding the name of the account was not changed from ‘Dr. Jean Eissengarthen, deceased’ to that of ‘Anna Floto de Eissengarthen,’ it immediately became her property and at all times prior to her death it was money on deposit in the United States for her use and benefit.”

    Practical Implications

    This case clarifies the scope of the Section 863(b) exclusion for bank deposits of nonresident aliens. It highlights that ownership of the funds, rather than the name on the account, is the determining factor. Legal practitioners should investigate the applicable foreign law to establish the heir’s rights and confirm the absence of U.S.-based creditors. If the nonresident alien is the outright owner of the funds, the exclusion is likely to apply, even if formal legal processes (like ancillary administration) are required to access the funds. Subsequent cases will likely distinguish this ruling based on the degree of control the nonresident alien had over the funds and the presence of any encumbrances or potential claims against the funds.