OCTOBER TERM, 2002
Syllabus
BOEING CO. ET AL.
v. UNITED STATES
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE NINTH
CIRCUIT
No. 01-1209. Argued December 9, 2002-Decided March 4, 2003*
Under a 1971 statute providing special tax treatment for export
sales made by an American manufacturer through a subsidiary that
qualified as a "domestic international sales corporation" (DISC),
no tax is payable on the DISC's retained income until it is
distributed. See 26 U. S. C. §§ 991-997. The statute thus provides
an incentive to maximize the DISC's share-and to minimize the
parent's share-of the parties' aggregate income from export sales.
The statute provides three alternative ways for a parent to divert
a limited portion of its income to the DISC. See §§ 994(a)(1)-(3).
The alternative that The Boeing Company chose limited the DISC's
taxable income to a little over half of the parties "combined
taxable income" (CTI). In 1984, the "foreign sales corporation"
(FSC) provisions replaced the DISC provisions. As under the DISC
regime, it is in the parent's interest to maximize the FSC's share
of the taxable income generated by export sales. Because most of
the differences between these regimes are immaterial to this suit,
the Court's analysis focuses mainly on the DISC provisions. The
Treasury Regulation at issue, 26 CFR § 1.861-8(e)(3) (1979),
governs the accounting for research and development (R&D)
expenses when a taxpayer elects to take a current deduction,
telling the taxpaying parent and its DISC "what" must be treated as
a cost when calculating CTI, and "how" those costs should be (a)
allocated among different products and (b) apportioned between the
DISC and its parent. With respect to the "what" question, the
regulation includes a list of Standard Industrial Classification
(SIC) categories (e. g., transportation equipment) and requires
that R&D for any product within the same category as the
exported product be taken into account. The regulations use gross
receipts from sales as the basis for both "how" questions. Boeing
organized its internal operations along product lines (e. g.,
aircraft model 767) for management and accounting purposes, each of
which constituted a separate "program" within the organization; and
$3.6 billion of its R&D expenses were spent on "Company
Sponsored Product Development," i.
e., product-specific
research. Boeing's accountants treated all
*Together with No. 01-1382,
United States v.
Boeing
Sales Corp. et al., also on certiorari to the same court.
438
Syllabus
Company Sponsored costs as directly related to a single program
and unrelated to any other program. Because nearly half of the
Company Sponsored R&D at issue was allocated to programs that
had no sales in the year in which the research was conducted, that
amount was deducted by Boeing currently in calculating its taxable
income for the years at issue, but never affected the calculation
of the CTI derived by Boeing and its DISC from export sales. The
Internal Revenue Service reallocated Boeing's Company Sponsored
R&D costs for 1979 to 1987, thereby decreasing the untaxed
profits of its export subsidiaries and increasing its taxable
profits on export sales. After paying the additional taxes, Boeing
filed this refund suit. In granting Boeing summary judgment, the
District Court found § 1.861-8(e)(3) invalid, reasoning that its
categorical treatment of R&D conflicted with congressional
intent that there be a direct relationship between items of gross
income and expenses related thereto, and with a specific DISC
regulation giving the taxpayer the right to group and allocate
income and costs by product or product line. The Ninth Circuit
reversed.
Held: Section 1.861-8(e)(3) is a proper exercise of the
Secretary of the Treasury's rulemaking authority. Pp. 446-457.
(a) The relevant statutory text does not support Boeing's
argument that the statute and certain regulations give it an
unqualified right to allocate its Company Sponsored R&D
expenses to the specific products to which they are factually
related and to exclude such R&D from treatment as a cost of any
other product. The method that Boeing chose to determine an export
sale's transfer price allowed the DISC "to derive taxable income
attributable to [an export sale] in an amount which
does not
exceed ... 50 percent of the
combined taxable income of
[the DISC and the parent] which is
attributable to the
qualified export receipts on such property derived as the result of
a sale by the DISC plus 10 percent of the export promotion expenses
of such DISC attributable to such receipts .... " 26 U. S. C. §
994(a)(2) (emphasis added). The statute does not define "combined
taxable income" or specifically mention R&D expenditures. The
Secretary's regulation must be treated with deference, see
Cottage Savings Assn. v.
Commissioner, 499 U. S. 554, 560561,
but the statute places some limits on the Secretary's interpretive
authority. First, "does not exceed" places an upper limit on the
share of the export profits that can be assigned to a DISC and
gives three methods of setting the transfer price. Second,
"combined taxable income" makes it clear that the domestic parent's
taxable income is a part of the CTI equation. Third, "attributable"
limits the portion of the domestic parent's taxable income that can
be treated as a part of the CTI. The Secretary's classification of
all R&D as an indirect cost of all export
439
sales of products in a broadly defined SIC category is not
arbitrary. It provides consistent treatment for cost items used in
computing the taxpayer's domestic taxable income and CTI; and its
allocation of R&D expenditures to all products in a category
even when specifically intended to improve only one or a few of
those products is no more tenuous than the allocation of a chief
executive officer's salary to every product that a company sells
even when he devotes virtually all of his time to the development
of the Edsel. Reading § 994 in light of § 861, the more general
provision dealing with the distinction between domestic and foreign
source income, does not support Boeing's contrary view. If the
Secretary reasonably determines that Company Sponsored R&D can
be properly apportioned on a categorical basis, the portion of §
861(b) that deducts from gross income "a ratable part of any
expenses ... which cannot definitely be allocated to some item or
class of gross income" is inapplicable. Pp. 446-451.
(b) Boeing's arguments based on specific DISC regulations are
also unavailing. Language in 26 CFR § 1.994-1(c)(6)(iii), part of
the rule describing CTI computation, does not prohibit a ratable
allocation of R&D expenditures that can be "definitely related"
to particular export sales. Whether such an expense can be
"definitely related" is determined by the rules set forth in the
very rule that Boeing challenges, § 1.861-8. Moreover, the
Secretary could reasonably determine that expenditures on model 767
research conducted in years before any 767's were sold were not
"definitely related" to any sales, but should be treated as an
indirect cost of producing the gross income derived from the sale
of all planes in the transportation equipment category. Nor do §§
1.994-1(c)(7)(i) and (ii)(a), which control grouping of
transactions for determining the transfer price of sales of export
property, and § 1.9941(c)(6)(iv), which governs the grouping of
receipts when the CTI method is used, speak to the questions
whether or how research costs should be allocated and apportioned.
Pp.451-455.
(c) What little relevant legislative history there is in this
suit weighs in the Government's favor. Pp. 455-457.
258 F.3d
958, affirmed.
STEVENS, J., delivered the opinion of the Court, in which
REHNQUIST, C. J., and O'CONNOR, KENNEDY, SOUTER, GINSBURG, and
BREYER, JJ., joined. THOMAS, J., filed a dissenting opinion, in
which SCALIA, J., joined,
post, p. 457.
Kenneth S.
Geller argued the cause for petitioners
in No. 01-1209 and respondents in No. 01-1382. With him on
440
the briefs were Charles Rothfeld, David M. Gossett, Alan 1.
Horowitz, Joel v: Williamson, Wayne S. Kaplan, Roger J. Jones,
Patricia Anne Yurchak, Marjorie M. Margolies, and John B.
Magee.
Kent L. Jones argued the cause for the United States in both
cases. With him on the brief were Solicitor General Olson,
Assistant Attorney General O'Connor, Deputy Solicitor General
Wallace, David English Carmack, and Frank P. Cihlar.t
JUSTICE STEVENS delivered the opinion of the Court. This suit
concerns tax provisions enacted by Congress in 1971 to provide
incentives for domestic manufacturers to increase their exports and
in 1984 to limit and modify those incentives. The specific question
presented involves the interpretation of a Treasury Regulation (26
CFR § 1.8618(e)(3) (1979)) promulgated in 1977 that governs the
accounting for research and development (R&D) expenses under
both statutory schemes.1 We shall explain the general outlines of
the two statutes before we focus on that regulation.
The 1971 statute provided special tax treatment for export sales
made by an American manufacturer through a subsidiary that
qualified as a "domestic international sales corporation" (DISC).2
The DISC itself is not a taxpayer; a portion of its income is
deemed to have been distributed to its shareholders, and the
shareholders must pay taxes on that portion,
tBriefs of
amici curiae urging reversal were filed for
Caterpillar, Inc., et al. by C.
David Swenson; for the
National Foreign Trade Council, Inc., by
Stephen D. Gardner;
and for the Tax Executives Institute, Inc., by
Fred
1 In 1996, the provisions of 26 CFR § 1.861-8 were amended,
renumbered, and republished as 26 CFR § 1.861-17. See 26 CFR §
1.861-17 (2002); see also 60 Fed. Reg. 66503 (1995).
2 To qualify as a DISC, at least 95 percent of a corporation's
gross receipts must arise from qualified export receipts. See 26 U.
S. C. § 992(a)(1)(A). In addition, at least 95 percent of the
corporation's assets must be export related. See §
992(a)(1)(B).
441
but no tax is payable on the DISC's retained income until it is
actually distributed. See 26 U. S. C. §§ 991-997. Typically, "a
DISC is a wholly owned subsidiary of a U. S. corporation." 1 Senate
Finance Committee, Deficit Reduction Act of 1984, 98th Cong., p.
630, n. 1 (Comm. Print 1984) (hereinafter Committee Print). The
statute thus provides an incentive to maximize the DISC's share-and
to minimize the parent's share-of the parties' aggregate income
from export sales.
The DISC statute does not, however, allow the parent simply to
assign all of the profits on its export sales to the DISC. Rather,
"to avoid granting undue tax advantages," 3 the statute provides
three alternative ways in which the parties may divert a limited
portion of taxable income from the parent to the DISC. See 26 U. S.
C. §§ 994(a)(1)-(3). Each of the alternatives assumes that the
parent has sold the product to the DISC at a hypothetical "transfer
price" that produced a profit for both seller and buyer when the
product was resold to the foreign customer. The alternative used by
Boeing in this suit limited the DISC's taxable income to a little
over half of the parties' "combined taxable income" (CTI).4
3 S. Rep. No. 92-437, p. 13 (1971) (hereinafter S. Rep.).
4 To be more precise, it allowed the DISC "to derive taxable
income attributable to [an export sale] in an amount which does not
exceed ... 50 percent of the combined taxable income of [the DISC
and the parent] plus 10 percent of the export promotion expenses of
such DISC attributable to such receipts .... " 26 U. S. C. §
994(a)(2).
A hypothetical example in both the House and Senate Committee
Reports illustrated the computation of a transfer price of $816
based on a DISC's selling price of $1,000 and the parent's cost of
goods sold of $650. The gross margin of $350 was reduced by $180
(including the DISC's promotion expenses of $90, the parent's
directly related selling and administrative expenses of $60, and
the parent's prorated indirect expenses of $30), to produce a CTI
of $170. Half of that amount ($85) plus 10 percent of the DISC's
promotion expenses ($9) gave the DISC its allowable taxable income
of $94, leaving only $76 of income immediately taxable to the
parent. The $184 aggregate of the two amounts attributed to the
DISC (promotion expenses of $90 plus its $94 share of CTI)
subtracted from the
442
Soon after its enactment, the DISC statute became "the subject
of an ongoing dispute between the United States and certain other
signatories of the General Agreement on Tariffs and Trade (GATT)"
regarding whether the DISC provisions were impermissible subsidies
that violated our treaty obligations. Committee Print 634. "To
remove the DISC as a contentious issue and to avoid further
disputes over retaliation, the United States made a commitment to
the GATT Council on October 1, 1982, to propose legislation that
would address the concerns of other GATT members."
Id., at
634635. This ultimately resulted in the replacement of the DISC
provisions in 1984 with the "foreign sales corporation" (FSC)
provisions of the Code. See Deficit Reduction Act of 1984, Pub. L.
98-369, §§ 801-805,98 Stat. 985.5
Unlike a DISC, an FSC is a foreign corporation, and a portion of
its income is taxable by the United States. See ibid.; see also B.
Bittker & J. Eustice, Federal Income Taxation of Corporations
and Shareholders ~ 17.14 (5th ed. 1987). Whereas a portion of a
DISC's income was tax deferred, a portion of an FSC's income is
exempted from taxation. Compare 26 U. S. C. §§ 991-997 with 26 U.
S. C. §§ 921, 923 (1988 ed.). Hence, under the FSC regime, as under
the DISC regime, it is in the parent's interest to maximize the
FSC's share of the taxable income generated by export sales.
Because the differences between the DISC and FSC regimes for the
most part are immaterial to this suit, the analysis in this opinion
will focus mainly on the DISC provisions.6
The Internal Revenue Code gives the taxpayer an election either
to capitalize and amortize the costs of R&D over a period of
years or to deduct such expenses currently. See
$1,000 gross receipt produced the "transfer price" of $816. See
S. Rep., at 108, n. 7; H. R. Rep. No. 92-533, p. 74, n. 7 (1971)
(hereinafter H. R. Rep.). 5 In 2000, Congress repealed and replaced
the FSC provisions with the "extraterritorial income" exclusion of
26 U. S. C. § 114.
6 Two aspects of the 1984 statute that do have special
significance to this suit are discussed in Part IV,
infra.
443
26 U. S. C. § 174. The regulation at issue here, 26 CFR §
1.861-8(e)(3) (1979), deals with R&D expenditures for which the
taxpayer has taken a current deduction. It tells the taxpaying
parent and its DISC "what" must be treated as a cost when
calculating CTI, and "how" those costs should be (a) allocated
among different products and (b) apportioned between the DISC and
its parent.7
With respect to the "what" question, the Treasury might have
adopted a broad approach defining the relevant R&D as including
all of the parent's products, or a narrow approach defining the
relevant R&D as all R&D directly related to a particular
product being exported. Instead, the regulation includes a list of
two-digit Standard Industrial Classification (SIC) categories
(examples are "chemicals and allied products" and "transportation
equipment"), and it requires that R&D for any product within
the same category as the exported product be taken into account.8
See
ibid. The regulation explains that R&D on any
product "is an inherently speculative activity" that sometimes
contributes unexpected benefits on other products, and "that the
gross income derived from successful research and development must
bear the cost of unsuccessful research and development."
Ibid.
With respect to the two "how" questions, the regulations use
gross receipts from sales as the basis both for allocating the
costs among the products within the broad R&D categories and
also for apportioning those costs between the parent and the DISC.
Thus, if the exported product constitutes 20 percent of the
parties' total sales of all products within an
7Treasury Regulation § 1.861-8 (1979) also specifies how other
specific items of expense should be treated. See,
e. g., 26
CFR § 1.861-8(e)(2) (1979) (interest fees); § 1.861-8(e)(5) (legal
and accounting fees); § 1.8618(e)(6) (income taxes).
8 The original regulation used two-digit SIC categories. See §
1.8618(e)(3). The current regulation uses narrower three-digit SIC
categories, see 26 CFR § 1.861-17(a)(2)(ii) (2002), but the change
is not relevant to this suit.
444
R&D category, 20 percent of the R&D cost is allocated to
that product. And if export sales represent 70 percent of the total
sales of that product, 70 percent of that amount, or 14 percent of
the R&D, is apportioned to the DISC.
I
Petitioners (and cross-respondents) are The Boeing Company and
subsidiaries that include a DISC and an FSC. For over 40 years
Boeing has been a world leader in commercial aircraft development
and a major exporter of commercial aircraft. During the period at
issue in this litigation, the dollar volume of its sales amounted
to about $64 billion, 67 percent of which were DISC-eligible export
sales. The amount that Boeing spent on R&D during that period
amounted to approximately $4.6 billion.
During the tax years at issue here, Boeing organized its
internal operations along product lines (e. g., aircraft models
727, 737, 747, 757, 767) for management and accounting purposes,
each of which constituted a separate "program" within the Boeing
organization. For those purposes, it divided its R&D expenses
into two broad categories: "Blue Sky" and "Company Sponsored
Product Development." The former includes the cost of broad-based
research aimed at generally advancing the state of aviation
technology and developing alternative designs of new commercial
planes. The latter includes product-specific research pertaining to
a specific program after the board of directors has given its
approval for the production of a new model. With respect to its $1
billion of "Blue Sky" R&D, Boeing's accounting was essentially
consistent with 26 CFR § 1.861-8(e)(3) (1979).9 Its
9 Because all of Boeing's commercial aircraft were
"transportation equipment" within the meaning of the Treasury
Regulation, it properly allocated all of its Blue Sky research
among all of its programs, and then apportioned those costs between
the parent and the DISC. However, according to the Government, it
erroneously did so on the basis of hours of direct labor rather
than sales. See Brief for United States 10.
445
method of accounting for $3.6 billion of "Company Sponsored"
R&D gave rise to this litigation.
Boeing's accountants treated all of the Company Sponsored
research costs as directly related to a single program, and as
totally unrelated to any other program. Thus, for DISC purposes,
the cost of Company Sponsored R&D directly related to the 767
model, for example, had no effect on the calculation of the
"combined taxable income" produced by export sales of any other
models. Moreover, because immense Company Sponsored research costs
were routinely incurred while a particular model was being
completed and before any sales of that model occurred, those costs
effectively "disappeared" in the calculation of the CTI even for
the model to which the R&D was most directly related.lO Almost
half of the $3.6 billion of Company Sponsored R&D at issue in
this suit was allocated to programs that had no sales in the year
in which the research was conducted. That amount (approximately
$1.75 billion) was deducted by Boeing currently in the calculation
of its taxable income for the years at issue, but never affected
the calculation of the CTI derived by Boeing and its DISC from
export sales.
Pursuant to an audit, the Internal Revenue Service reallocated
Boeing's Company Sponsored R&D costs for the years 1979 to
1987, thereby decreasing the untaxed profits of its export
subsidiaries and increasing the parent's taxable profits from
export sales. Boeing paid the additional tax obligation of $419
million and filed this suit seeking a refund. Relying on the
decision of the Eighth Circuit in
St. Jude Medical, Inc. v.
Commissioner, 34 F.3d
1394 (1994), the District Court entered summary judgment in
favor of Boeing. It held that 26 CFR § 1.861-8(e)(3) (1979) is
invalid as applied to DISC and FSC transactions because the
regulation's cate-
10 When Boeing charged R&D costs to programs that had no
sales in the year the research was conducted, the R&D costs
effectively "disappeared" in the sense that they were not accounted
for by Boeing in computing its CTI.
446
gorical treatment of R&D conflicted with congressional
intent that there be a "direct" relationship between items of gross
income and expenses "related thereto," and with a specific DISC
regulation giving the taxpayer the right to group and allocate
income and costs by product or product line. The Court of Appeals
for the Ninth Circuit reversed,
258 F.3d
958 (2001), and we granted certiorari to resolve the conflict
between the Circuits, 535 U. S. 1094 (2002). We now affirm.
II
Section 861 of the Internal Revenue Code distinguishes between
United States and foreign source income for several different
purposes. See 26 U. S. C. § 861. The regulation at issue in this
suit, 26 CFR § 1.861-8(e)(3) (1979), was promulgated pursuant to
that general statute. Separate regulations promulgated under the
DISC statute, 26 U. S. C. §§ 991-997, incorporate 26 CFR §
1.861-8(e)(3) (1979) by specific reference. See §
1.994-1(c)(6)(iii) (citing and incorporating the cost allocation
rules of § 1.861-8). Boeing does not claim that its method of
accounting for Company Sponsored R&D complied with §
1.861-8(e)(3). Rather, it argues that § 1.861-8(e)(3) is so plainly
inconsistent with congressional intent and with other provisions of
the DISC regulations that it cannot be validly applied to its
computation of CTI for DISC purposes.
Boeing argues, in essence, that the statute and certain specific
regulations promulgated pursuant to 26 U. S. C. § 994 give it an
unqualified right to allocate its Company Sponsored R&D
expenses to the specific products to which they are "factually
related" and to exclude any allocated R&D from being treated as
a cost of any other product. The relevant statutory text does not
support its argument.
As we have already mentioned, the DISC statute gives the
taxpayer a choice of three methods of determining the transfer
price for an exported good. Boeing elected to use only the second
method described in the following text:
447
"Inter-company pricing rules "(a) In general
"In the case of a sale of export property to a DISC by a person
described in section 482, the taxable income of such DISC and such
person shall be based upon a transfer price which would allow such
DISC to derive taxable income attributable to such sale (regardless
of the sales price actually charged) in an amount
which does not
exceed the greatest of-
"(1) 4 percent of the qualified export receipts on the sale of
such property by the DISC plus 10 percent of the export promotion
expenses of such DISC attributable to such receipts,
"(2) 50 percent of the
combined taxable income of such
DISC and such person which is
attributable to the qualified
export receipts on such property derived as the result of a sale by
the DISC plus 10 percent of the export promotion expenses of such
DISC attributable to such receipts, or
"(3) taxable income based upon the sale price actually charged
(but subject to the rules provided in section 482).
"(b) Rules for commissions, rentals, and marginal costing
"The Secretary shall prescribe regulations setting forth
"(2) rules for the allocation of expenditures in
computing combined taxable income under subsection (a)(2) in those
cases where a DISC is seeking to establish or maintain a market for
export property." 26 U. S. C. §§ 994(a)(1)-(3), (b)(2) (emphasis
added).
The statute does not define the term "combined taxable income,"
nor does it specifically mention expenditures for R&D. Congress
did grant the Secretary express authority to prescribe regulations
for determining the proper alloca-
448
tion of expenditures in computing CTI in certain specific
contexts. See,
e. g., §§ 994(b)(1)-(2). Yet in promulgating
26 CFR § 1.861-8 (1979), the Secretary of the Treasury exercised
his rulemaking authority under 26 U. S. C. § 7805(a), which gives
the Secretary general authority to "prescribe all needful rules and
regulations for the enforcement" of the Internal Revenue Code. See
41 Fed. Reg. 49160 (1976) ("The proposed regulations are to be
issued under the authority contained in section 7805 of the
Internal Revenue Code"). Even if we regard the challenged
regulation as interpretive because it was promulgated under §
7805(a)'s general rulemaking grant rather than pursuant to a
specific grant of authority, we must still treat the regulation
with deference. See
Cottage Savings Assn. v.
Commissioner, 499 U. S. 554, 560-561 (1991).
The words that we have emphasized in the statutory text do place
some limits on the Secretary's interpretive authority. First, the
"does not exceed" phrase places an upper limit on the share of the
export profits that can be assigned to a DISC and also gives the
taxpayer an unfettered right to select any of the three methods of
setting a "transfer price." Second, the use of the term "combined
taxable income" in subsection (a)(2) makes it clear that the
taxable income of the domestic parent is a part of the equation
that should produce the CTI. As Boeing recognizes, even a
charitable contribution to the Seattle Symphony that reduces its
domestic earnings from sales of 767's must be treated as a cost
that is not definitely related to any particular category of income
and thus must be apportioned among all categories of income,
including income from export sales. See Brief for Petitioners in
No. 01-1209, p. 8, n. 7. Third, the word "attributable" places a
limit on the portion of the domestic parent's taxable income that
can be treated as a part of the CTI. It is this word that provides
the statutory basis for Boeing's position.
449
Under Boeing's reading of the statute, a calculation of the
domestic income "attributable" to the export sale of a 767 may
include both the direct and indirect costs of manufacturing and
selling 767's, but it may not include the direct costs of selling
anything else. Moreover, if Boeing's accountants classify a
particular cost as directly related to the 767, that classification
is conclusive. Thus, while the Secretary asserts that Boeing's
R&D expenses are definitely related to all income in the
relevant SIC category, Boeing claims the right to divide its
R&D in a way that effectively creates three segments: (1) Blue
Sky; (2) Company Sponsored R&D on products that have no sales
in the current year; and (3) Company Sponsored R&D on products
that are being sold currently. Boeing, like the Secretary,
essentially treats Blue Sky R&D as an indirect cost in
computing both its domestic taxable income and its CTI. With
respect to the second segment, Boeing uses the R&D to reduce
its domestic taxable earnings on every product it sells, but
eliminates it entirely from the calculation of CTI on any product
by charging the R&D costs to programs without any sales. The
third segment is used for both domestic and CTI purposes, but with
respect to CTI only for the export sales to which it is "factually
related."
The Secretary's classification of all R&D as an indirect
cost of all export sales of products in a broadly defined SIC
category-in other words, as "attributable" to such sales-is surely
not arbitrary. It has the virtue of providing consistent treatment
for cost items used in computing the taxpayer's domestic taxable
income and its CTI. Moreover, its allocation of R&D
expenditures to all products in a category even when specifically
intended to improve only one or a few of those products is no more
tenuous than the allocation of a chief executive officer's salary
to every product that a company sells even when he devotes
virtually all of his time to the development of an Edsel.
450
On the other hand, even if Boeing's method of accounting for
R&D is fully justified for management purposes, it certainly
produces anomalies for tax purposes. Most obvious is the fact that
it enabled Boeing to deduct some $1.75 billion of expenditures from
its domestic taxable earnings under 26 U. S. C. § 174 and never
deduct a penny of those expenditures from its "combined taxable
earnings" under the DISC statute. See Brief for Petitioners in No.
01-1209, at 11. Less obvious, but nevertheless significant, is that
Boeing's method assumed that Blue Sky research produces benefits
for airplane models that are producing current income and-at the
same time-assumed that Company Sponsored research related to a
specific product, such as the 727, is not likely to produce
benefits for other airplane models, such as the 737 or 767.11
In all events, the mere use of the word "attributable" in the
text of § 994 surely does not qualify the Secretary's authority to
decide whether a particular tax deductible expenditure made by the
parent of a DISC is sufficiently related to its export sales to
qualify as an indirect cost in the computation of the parties' CTI.
Boeing argues, however, that the text of § 994 should be read in
light of § 861, the more general provision dealing with the
distinction between domestic and foreign source income.
Title 26 U. S. C. § 861(b) contains the following two
sentences:
"Taxable income from sources within United States "From the
items of gross income specified in subsection (a) as being income
from sources within the United States there shall be deducted the
expenses, losses, and other deductions properly apportioned or
allocated
11 This assumption, of course, runs contrary to the Secretary's
determination that R&D "is an inherently speculative activity"
that sometimes contributes unexpected benefits on other products.
26 CFR § 1.8618(e)(3)(i)(A) (1979).
451
thereto and a ratable part of any expenses, losses, or
other deductions which cannot definitely be allocated to some
item or class of gross income. The remainder, if any, shall be
included in full as taxable income from sources within the United
States." (Emphasis added.)
Focusing on the emphasized words, Boeing interprets this section
as having created a background rule dividing all expenses into two
categories: those that can be allocated to specific income and
those that cannot. "Ratable" allocation is permissible for the
second category, but not for the first, according to Boeing.
Moreover, in Boeing's view, any expense in the first category
cannot be ratably apportioned across all classes of income.
There are at least two flaws in this argument. First, although
the emphasized words authorize ratable apportionment of costs that
cannot definitely be allocated to some item or class of income, the
sentence as a whole does not prohibit ratable apportionment of
expenses that could be, but perhaps in fairness should not be,
treated as direct costs. Second, the Secretary has the authority to
prescribe regulations determining whether an expense can be
properly apportioned to an item of gross income in the calculation
of CTI. See 26 U. S. C. § 7805(a). Thus, as in this suit, if the
Secretary reasonably determines that Company Sponsored R&D can
be properly apportioned on a categorical basis, the italicized
portion of § 861 is simply inapplicable.
In sum, Boeing's arguments based on statutory text are plainly
insufficient to overcome the deference to which the Secretary's
interpretation is entitled.
III
Boeing also advances two arguments based on the text of specific
DISC regulations. The first resembles its argument based on the
text of § 861, and the second relies on regulations providing that
certain accounting decisions made by the taxpayer shall be
controlling.
452
The regulations included in 26 CFR § 1.994-1 (1979) set forth
intercompany pricing rules for DISCs. They generally describe the
three methods of determining a transfer price, noting that the
taxpayer may choose the most favorable method, and may group
transactions to use one method for some export sales and another
method for others. See
ibid. With respect to the CTI method
used by Boeing, there is a rule, § 1.994-1(c)(6), that describes
the computation of CTI. The rule broadly defines the CTI of a DISC
and its related supplier from a sale of export property as the
excess of gross receipts over their total costs "which relate to
such gross receipts." 12 Subdivision (iii) of that rule, on which
Boeing relies, provides:
"Costs (other than cost of goods sold) which shall be treated as
relating to gross receipts from sales of export property are (a)
the expenses, losses, and other deductions definitely
related, and therefore allocated and ap-
12 Treasury Regulation § 1.994-1(c)(6), 26 CFR § 1.994-1(c)(6)
(1979), provides in part:
"Combined taxable income. For purposes of this section,
the combined taxable income of a DISC and its related supplier from
a sale of export property is the excess of the gross receipts (as
defined in section 993(f)) of the DISC from such sale over the
total costs of the DISC and related supplier which relate to such
gross receipts. Gross receipts from a sale do not include interest
with respect to the sale. Combined taxable income under this
paragraph shall be determined after taking into account under
paragraph (e)(2) of this section all adjustments required by
section 482 with respect to transactions to which such section is
applicable. In determining the gross receipts of the DISC and the
total costs of the DISC and related supplier which relate to such
gross receipts, the following rules shall be applied:
"(i) Subject to subdivisions (ii) through (v) of this
subparagraph, the taxpayer's method of accounting used in computing
taxable income will be accepted for purposes of determining amounts
and the taxable year for which items of income and expense
(including depreciation) are taken into account. See §
1.991-1(b)(2) with respect to the method of accounting which may be
used by a DISC."
453
portioned, thereto, and (b) a ratable part of any other
expenses, losses, or other deductions which are not definitely
related to a class of gross income, determined in a manner
consistent with the rules set forth in § 1.861-8." §
1.994-1(c)(6)(iii) (emphasis added).
Boeing interprets the emphasized words as prohibiting a ratable
allocation of R&D expenditures that can be "definitely related"
to particular export sales. The obvious response to this argument
is provided by the final words in the paragraph. Whether such an
expense can be "definitely related" is determined by the rules set
forth in the very regulation that Boeing challenges, § 1.861-8.
Moreover, it seems quite clear that the Secretary could reasonably
determine that expenditures on 767 research conducted in years
before any 767's were sold were not "definitely related" to any
sales, but should be treated as an indirect cost of producing the
gross income derived from the sale of all planes in the
transportation equipment category.
Boeing also argues that the regulations expressly allow it to
allocate and apportion R&D expenses to groups of export sales
that are based on industry usage rather than SIC categories. The
regulations providing the strongest support for this argument are
§§ 1.994-1(c)(7)(i) and (ii)(a), which control the grouping of
transactions for the purpose of determining the transfer price of
sales of export property, and § 1.9941(c)(6)(iv), which governs the
grouping of receipts when the CTI method of transfer pricing is
used.13 Treasury Regulation § 1.994-1(c)(7) reads, in part, as
follows:
13 In support of its argument that §§ 1.994-1(c) and
1.861-8(e)(3) conflict, Boeing also points to various proposed
regulations, including example 1 of proposed regulation §
1.861-8(g). See Brief for Petitioners in No. 011209, pp. 22-26.
Unlike Boeing and the dissent, see
post, at 458-459 (opinion
of THOMAS, J.), we find these proposed regulations to be of little
consequence given that they were nothing more than mere proposals.
In 1972-when regulations governing DISCs were first proposed-the
Secre-
454
"Grouping transactions. (i) Generally, the determinations
under this section are to be made on a transactionby-transaction
basis. However, at the annual choice of the taxpayer some or all of
these determinations may be made on the basis of groups consisting
of products or product lines.
"(ii) A determination by a taxpayer as to a product or a product
line will be accepted by a district director if such determination
conforms to anyone of the following standards: (a) A recognized
industry or trade usage, or (b) the 2-digit major groups ...
of the Standard Industrial Classification .... "
As we understand the statutory and regulatory scheme, it gives
controlling effect to three important choices by the taxpayer.
First, the taxpayer may elect to deduct R&D expenses on an
annual basis instead of capitalizing and amortizing those costs.
See 26 U. S. C. § 174(a)(1). Second, when engaging in export
transactions with a DISC, the taxpayer may choose anyone of the
three methods of determining the transfer price. See § 994(a).
Third, the taxpayer may decide how best to group those transactions
for purposes of applying the transfer pricing methods. See 26 CFR §
1.9941(c)(7) (1979). Conceivably, the taxpayer could account for
each sale separately, by product lines, or by grouping all of its
export sales together. These regulations confirm the finality of
the third type of choice (i.
e., which groups of sales will
be evaluated under one of the three alternative transfer pricing
methods), but do not speak to the questions answered by the
regulation at issue in this suit-namely, whether or
tary made clear that the proposed regulations were suggestions
only and that whatever final regulations were ultimately adopted
would govern. See Technical Memorandum accompanying Notice of
Proposed Rulemaking, 1972 T. M. Lexis 14, pp. *8-*9 (June 29, 1972)
(providing that in determining deductible expenses, "the rules of
section 861(b) and § 1.861-8 are to be applied in whatever form
they ultimately take in a new notice to be prepared").
455
how a particular research cost should be allocated and
apportioned.
Nor does § 1.994-1(c)(6)(iv) support Boeing's argument.
It provides that a "taxpayer's choice in accordance with
subparagraph (7) of this paragraph as to the grouping of
transactions shall be controlling, and costs deductible in a
taxable year shall be allocated and apportioned to the items or
classes of gross income of such taxable year resulting from such
grouping." The regulation makes clear that if the taxpayer selects
the CTI method of transfer pricing (as Boeing did), then the
taxpayer may choose to group export receipts according to product
lines, two-digit SIC codes, or on a transaction-by-transaction
basis.
Ibid. The regulation also establishes that there
shall be an allocation and apportionment of all relevant costs
deducted in the taxable year.
Ibid. Notably, however, the
regulation simply does not speak to how costs should be allocated
among different items or classes of gross income and apportioned
between the DISC and its parent once the taxpayer (pursuant to §
1.994-1(c)(6)) groups its gross receipts. Treasury Regulation §
1.861-8(e)(3) fills this gap by providing that R&D expenditures
that are related to all income reasonably connected with the
taxpayer's relevant two-digit SIC category or categories are
"allocable to all items of gross income as a class ...
related to such product category (or categories)." 26 CFR §
1.861-8(e)(3) (1979) (emphasis added).
IV
Boeing also relies heavily on legislative history, particularly
on statements in Reports prepared by the tax-writing committees of
the House and the Senate on the DISC statute. Those Reports are
virtually identical in terms of their discussion of the DISC
provisions. See H. R. Rep., at 58-95; S. Rep., at 90-129. Neither
says anything about R&D costs. They both contain statements
supporting the proposition that in determining how to calculate
income that qualifies
456
for a tax benefit, the expenses to be deducted from gross income
are those expenses that are "directly related" to the income. See
H. R. Rep., at 74; S. Rep., at 107. Those statements are not,
however, inconsistent with the proposition that particular R&D
expenses may be factually related to more than one item of income,
or with the proposition that the Secretary has broad authority to
promulgate regulations determining which expenses are directly or
indirectly related to particular items of income.
If anything, what little relevant legislative history there is
in this suit weighs in favor of the Government's position in two
important respects. First, whereas the DISC transfer price could be
set at a level that attributed over half of the CTI to the DISC,
when Congress enacted the FSC provisions in 1984, it lowered the
maximum allowable share of CTI attributable to an FSC to 23
percent. Compare 26 U. S. C. § 994(a)(2) with 26 U. S. C. §
925(a)(2) (1988 ed.). This dramatizes the point that even though
the purpose of the DISC and FSC statutes was to provide American
firms with a tax incentive to increase their exports, Congress did
not intend to grant "undue tax advantages" to firms. S. Rep., at
13. Rather, the statutory formulas were designed to place ceilings
on the amount of those special tax benefits. See Committee Print
636 ("[T]he income of the foreign sales corporation must be
determined according to transfer prices specified in the bill:
either actual prices for sales between unrelated, independent
parties or, if the sales are between related parties, formula
prices which are intended to comply with GATT's requirement of
arm's-length prices").
Second, the 1977 R&D regulation at issue in this suit had
been in effect for seven years when Congress enacted the FSC
provisions. Yet Congress did not legislatively override 26 CFR §
1.861-8(e)(3) (1979) in enacting the FSC provisions. In fact,
although a moratorium was placed on the application of §
1.861-8(e)(3) for purposes of the sourcing of income in
457
1981,14 a 1984 conference agreement specified that the
moratorium would "not apply for other purposes, such as the
computation of combined taxable income of a DISC (or FSC) and its
related supplier." H. R. Conf. Rep. No. 98-861, p. 1263 (1984). The
fact that Congress did not legislatively override 26 CFR §
1.861-8(e)(3) (1979) in enacting the FSC provisions in 1984 serves
as persuasive evidence that Congress regarded that regulation as a
correct implementation of its intent. See
Lorillard v.
Pons, 434 U.
S. 575, 580-581 (1978).
The judgment of the Court of Appeals is affirmed.
It is so ordered.
JUSTICE THOMAS, with whom JUSTICE SCALIA joins, dissenting.
Before placing its hand in the taxpayer's pocket, the Government
must place its finger on the law authorizing its action.
United
Dominion Industries, Inc. v.
United States, 532 U. S. 822, 839 (2001)
(THOMAS, J., concurring) (citing
Leavell v.
Blades,
237 Mo. 695, 700-701, 141 S. W. 893, 894 (1911)). Despite the
Government's failure to do so here, the Court holds in its favor; I
respectfully dissent.
To read the majority opinion, one would think that the Court has
before it a perfectly clear statutory and regulatory scheme and
that the position of petitioners/cross-respondents (hereinafter
Boeing) is utterly without support. Nothing could be further from
the facts of this suit. Indeed, the Internal Revenue Service (IRS)
itself initially read the statu-
14 In 1981, Congress imposed a temporary moratorium on the
application of the cost allocation rules of 26 CFR § 1.861-8(e)(3)
(1979) solely for the geographic sourcing of income. See Economic
Recovery Tax Act of 1981, Pub. L. 97-34, § 223, 95 Stat. 249. As a
result, research expenditures made for research conducted in the
United States were allocated against United States source gross
income only-not between United States source income and foreign
source income. See H. R. Conf. Rep. No. 98-861, p. 1262 (1984).
458
tory and regulatory provisions at issue here to permit precisely
what Boeing asserts it is allowed to do.1
When regulations governing DISCs were first proposed in 1972,
the IRS received public comments recommending that the regulations
be amplified to include rules and examples on how expenses should
be treated for purposes of determining the combined taxable income
of the DISC and a related supplier. The IRS, however, declined to
incorporate the recommendations in the final regulations,
explaining that proposed regulation § 1.861-8, which had been
published in 1973, provided ample guidance on the subject.
Technical Memorandum accompanying T. D. 7364,1974 T. M. Lexis 30,
pp. *20-*21 (Oct. 29, 1974).
Proposed regulation § 1.861-8(e)(3), in turn, explained that
where "research and development ... is intended or is reasonably
expected to result in the improvement of specific properties or
processes, deductions in connection with such research and
development shall be considered definitely related and therefore
allocable to the class of gross income to which the properties or
processes give rise or are reasonably
expected to give
rise." 38 Fed. Reg. 15843 (1973). The regulations went on to note
that in "other cases, as in the case of most basic research,
research and development shall generally be considered definitely
related and therefore allocable to all gross income of the current
taxable year which is likely to benefit from the research and
development."
Ibid. Example 1 in § 1.861-8(g) illustrated
this principle by considering the research and development
(R&D) expenditures of a corporation manufacturing four-, six-,
and eight-cylinder gasoline engines. The corporation conducted both
general and engine-specific research. The example made clear
that,
1 Because, as the Court notes,
ante, at 442, differences
in the rules governing domestic international sales corporations
(DISCs) and foreign sales corporations do not affect the outcome of
this suit, I too focus only on the relevant DISC provisions.
459
while general R&D expenses were "definitely related" to
gross income resulting from sales of all three types of engines,
R&D expenses in connection with a specific type of engine were
to be allocated only to gross income arising from sales of that
type of engine.
Id., at 15846 ("X's deductions for its
research and development expenses in connection with the 4 cylinder
engine are definitely related to the gross income to which the 4
cylinder engine gives rise, i.
e., gross income from the
sales of 4 cylinder engines ... ").
Indeed, the IRS' 1974 position on the proper allocation of
R&D expenses incurred in connection with separate lines of
products is the only one that makes sense under the relevant DISC
regulations. See,
e. g., 26 CFR §§ 1.994-1(c)(6), (7)
(1979). As the Court explains,
ante, at 440, 26 U. S. C. §
994 was designed to provide special tax treatment for American
companies engaged in export activities. To that end, § 994 permits
a DISC and its related supplier to compute their relevant transfer
price (and, relate diy, their income tax liability) based on one of
three methods. See § 994 (providing that the transfer price for
sales between a DISC and a related supplier can be computed based
on (1) the gross income method, (2) the combined taxable income
method, and (3) the usual transfer-pricing rules set forth in §
482).
The Treasury Department has promulgated regulations explaining
how the statutory framework must be applied. Section 1.994-1(c)(7)
of those regulations explains that, as a general rule, a
determination of the transfer price under § 994 is to be made on a
transaction-by-transaction basis. Section 1.994-1(c)(7), however,
provides that, instead of following the transaction-by-transaction
rule, taxpayers may make § 994 transfer price determinations based
on groups consisting of products or product lines. §
1.994-1(c)(7)(i). Specifically, the regulation states:
"A determination by a taxpayer as to a product or a product line
will be accepted by a district director if
460
such determination conforms to anyone of the following
standards: (a) A recognized industry or trade usage, or
(b)
the 2-digit major groups (or any inferior classifications or
combinations thereof, within a major group) of the Standard
Industrial Classification [SIC] as prepared by the [Office of
Management and Budget]." § 1.994-1(c)(7)(ii).
Section 1.994-1(c)(6)(iv), in turn, provides that, in connection
with the computation of combined taxable income, "[t]he taxpayer's
choice in accordance with [§ 1.994-1(c)(7)] as to the grouping of
transactions shall be controlling, and
costs deductible in a
taxable year shall be allocated and apportioned to the items or
classes of gross income of such taxable year resulting from such
grouping." (Emphasis added.) Thus, in tandem, §§
1.994-1(c)(6)(iv) and 1.994-1(c)(7) give a taxpayer the choice of
allocating and apportioning costs to items or classes of gross
income resulting from (1) case-by-case transactions, (2) products
or product lines grouped together based on industry or trade usage,
and (3) products or product lines grouped together based on 2-digit
SIC codes or lesser included subgroups.
Although under § 1.991-1(c)(7) taxpayers are given three choices
with respect to the proper grouping of export income
(and
the related allocation of
expenses), and although §
1.994-1(c)(6)(iv) provides that the taxpayer's selection under §
1.991-1(c)(7) shall be "controlling," § 1.861-8(e)(3) takes away
the very choices § 1.991-1 provides. Under § 1.861-8(e)(3), the
taxpayer is told that R&D expenses may be allocated
solely to items or classes of gross income resulting from
products that are within the same 2-digit SIC group-which happens
to be only one of the three options given under § 1.991-1(c)(7). In
my view, the rule set forth in § 1.861-8(e)(3) entirely eviscerates
the options given in § 1.991-1. Thus, despite the Court's efforts
to show that the two regulations complement, rather than
contradict, each
461
other,
ante, at 453-455, the conflict is irreconcilable.2
On these facts, a taxpayer should be permitted to compute its tax
liability under § 1.991-1, rather than under § 1.8618(e)(3), based
on the principle that a specific rule governs a general one.3 See
Morales v.
Trans World Airlines, Inc., 504 U. S. 374, 384
(1992);
Crawford Fitting Co. v. J.
T. Gibbons, Inc.,
482 U. S. 437,
445 (1987); see also
St. Jude Medical, Inc. v.
Commissioner, 34 F.3d
1394 (CA8 1994).
The Court disapproves of Boeing's method of allocating R&D
because, as the Court sees it, Boeing's approach results in the
"disappear[ance]" of relevant costs,
ante, at 445, in "the
sense that [R&D costs] were not accounted for by Boeing in
computing its [combined taxable income],"
ante, at 445, n.
10. The Court is troubled by the fact that this computation method
has enabled Boeing "to deduct some $1.75 billion of expenditures
from its domestic taxable earnings under 26 U. S. C. § 174 and
never deduct a penny of those expenditures from its 'combined
taxable earnings' under the DISC statute."
Ante, at 450. But
the "disappearance" of Boeing's R&D expenses is the direct
result of Congress' decision to encourage such expenditures by
making them immediately deductible under 26 U. S. C. § 174(a)(1).
Moreover, the approach adopted in the regulations, and approved by
the Court, does not remedy the alleged problem of disappearing
2 A taxpayer wishing to (1) group its sales based on an accepted
industry practice, for example, based on different models,
and (2) allocate its R&D expenses with respect to a
specific model to the items or classes of gross income resulting
from that model is not, on the Government's view, permitted to do
so. Rather, the taxpayer must first allocate R&D expenses
incurred in connection with the relevant model to items or classes
of gross income resulting from all models falling within the same
2-digit SIC group and only after doing so can the taxpayer deduct a
portion of that model's R&D expenses from the income earned by
sales of that model.
3With respect to a DISC, § 1.991-1 provides the more specific
rules because it applies only to DISCs, while § 1.861-8(e)(3) sets
forth more general rules because it applies to all taxpayers that
have foreign source income.
462
R&D expenses. A company that decides to enter the export
market with a product unrelated to its existing business remains
free to deduct in the current tax period all R&D expenses
incurred in connection with the new product, even though those
expenses would not be used to offset DISC income resulting from the
sale of existing products.4 Finally, neither the Court nor the
Government provides a satisfactory explanation for why § 861 can be
read to permit the "disappearance" of most expenses, see,
e.
g., 26 CFR § 1.8618(d)(1) (1979) ("Each deduction which bears a
definite relationship to a class of gross income shall be allocated
to that class ... even though, for the taxable year, no gross
income in such class is received or accrued .... In apportioning
deductions, it may be that, for the taxable year, there is no gross
income in the statutory grouping (or residual grouping), or that
deductions exceed the amount of gross income in the statutory
grouping (or residual grouping)"); see also 1 J. Isenbergh,
International Taxation: U. S. Taxation of Foreign Persons and
Foreign Income ~ 21.10 (3d ed. 2003) ("[I]f an expense incurred in
one year is properly allocable to income arising in another, the
expense will be allocated to the class to which the income belongs
and may therefore produce a loss in that class for the year"), but
to disallow the "disappearance" of R&D expenses.
4 Boeing illustrates this point with the following example:
Suppose a company that produces and exports athletic clothing (SIC
Code 23) decides to invest the proceeds of its clothing sales in
research to develop a line of athletic equipment (SIC Code 39). The
company has current DISC sales of $1 million from the athletic
clothing, no current sales of athletic equipment, and $500,000 in
athletic equipment R&D expenses. Under the regulations, the
$500,000 of equipment-related R&D will be allocated to the
athletic equipment SIC Code, which has no income. It will not be
allocated to the athletic clothing SIC Code to reduce the income
eligible for the DISC benefit related to the clothing. Thus, in the
words of the Court, the expense will simply "disappear." Brieffor
Petitioners in No. 01-1209, p. 37, n. 17.
463
Because I believe that § 1.861-8(e)(3) does not apply to a DISC,
I need not decide here whether § 1.861-8(e)(3) is consistent with
the text of § 861(b) and may be properly applied in other contexts.
I am puzzled, however, by the Court's assertion that the Secretary
is free to determine that certain expenses "can be properly
apportioned on a categorical basis,"
ante, at 451, and the
implication that the Secretary has authority to require "ratable
apportionment of expenses that could be, but perhaps in fairness
should not be, treated as direct costs."
Ibid. By its terms,
§ 861(b) appears to contemplate two types of expenses: (1) those
that can definitely be allocated to some item or class of gross
income and (2) those that
cannot. 26 U. S. C. § 861(b)
(providing for the deduction of
"the expenses, losses, and
other deductions properly apportioned or allocated thereto
and a
ratable part of any expenses, losses, or other deductions
which cannot definitely be allocated to some item or class of
gross income" (emphasis added)). Moreover, on its face, the
statute does not appear to permit expenses to be "deemed" related
to an item or class of gross income, even though in actual fact
they are not so related. Yet, § 1.861-8(e)(3) relies on the notion
of "deemed relationships." The regulation states that the methods
of allocation and apportionment established there "recognize that
research and development is an inherently speculative activity,
that findings may contribute unexpected benefits, and that the
gross income derived from successful research and development must
bear the cost of unsuccessful research and development." 26 CFR §
1.861-8(e)(3)(i)(A) (1979). The regulation then proceeds to require
the allocation of R&D expenses based on 2-digit SIC groups. But
neither the regulation nor the Court attempt to reconcile the
statutory text with the regulation's determination to allocate
certain R&D expenses to items or classes of gross income that
admittedly did not benefit from that research.
464
***
In short, I conclude that Boeing properly computed its tax
liability for the years at issue here. I would therefore reverse
the judgment of the Court of Appeals. Because the Court concludes
otherwise, I respectfully dissent.
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