Brief of Tax Executives Institute, Inc. as amicus curiae insupport of petitioners: interest of amicus curiae.

On August 9, 2002, Tax Executives Institute filed a brief amicus curiae in support of the petitioners with the Supreme Court of the United States in Boeing Company v. United States, No. 01-1209. The brief was filed under the aegis of TEI's International Tax Committee, whose chair is Judith P. Zelisko of Brunswick Corporation. TEI's brief in support of the petition for a writ of certiorari was published in the March-April issue of The Tax Executive.

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Pursuant to Rule 37 of the Rules of the Supreme Court, Tax Executives Institute, Inc. respectfully submits this brief as amicus curiae in support of Petitioners, the Boeing Company and its subsidiaries. (1) Tax Executives Institute ("TEI" or "the Institute") is a voluntary, nonprofit association of corporate and other business executives, managers, and administrators who are responsible for the tax affairs of their employers. The Institute was organized in 1944 and has approximately 5,300 members who represent more than 2,800 of the leading businesses in the United States, Canada, and Europe. The members of the Institute represent a cross-section of the business community in North America. The Institute is dedicated to promoting the uniform and equitable enforcement of the tax laws and to reducing the costs and burdens of administration and compliance to the benefit of both the government and taxpayers.

Members of the Institute have a vita] interest in this case, which involves the resolution of a sharp conflict concerning the interpretation of tax statutes affecting the foreign commerce of the United States. The substantive issue in the case is whether Treas. Reg. § 1.861-8(e)(3) (relating to the allocation of research and development expenses) is valid when its application frustrates the operation of the domestic international sales corporation (DISC) and foreign sales corporation (FSC) provisions of the Internal Revenue Code. Eight years ago, the U.S. Court of Appeals for the Eighth Circuit held in St. Jude Medical, Inc. v. Commissioner, 34 F. 3d 1394 (1994), that the Treasury Regulation is invalid in this context, noting that the mandated allocation method is inconsistent with Congress's intent to allocate costs to definitely related gross receipts. In the instant case, the U.S. Court of Appeals for the Ninth Circuit declined to follow St. Jude Medical and held instead that the regulation is valid. Amicus TEI submits that the Ninth Circuit's decision is wrong because it misapprehends the DISC and FSC statutory schemes and permits Treas. Reg. § 1.861-8(e)(3) not only to override the statute but also to undermine congressional intent.

This case has significant ramifications for taxpayers other than Boeing. The resolution of the question presented in this case affects the tax liabilities of thousands of other businesses that are also subject to these provisions. As individuals who must contend daily with the interpretation and administration of the nation's tax laws, the Institute's members have a vital interest in the proper disposition of this case.

Summary of Argument

1. For more than three decades, the domestic international sales corporation (DISC) and foreign sales corporation (FSC) provisions of the Internal Revenue Code have provided much needed tax relief for U.S. companies competing in foreign markets. Because of the similarity between the provisions, amicus TEI will focus primarily on the rules applicable to DISCs.

   This case involves how Boeing's research and development (R&D) expenses should be allocated to the revenues generated by its export sales of commercial aircraft for purposes of determining its allowable benefits under the DISC and FSC provisions. The issue arises because Treas. Reg. § 1.861-8(e)(3) requires taxpayers to allocate R&D expenditures according to the two-digit Standard Industrial Classification (SIC) Manual produced by the Office of Management and Budget. The DISC regulations, however, allow taxpayers greater flexibility, permitting them to group transactions along product lines.

   In determining its combined taxable income (CTI) during 1979 through 1987, Boeing exercised its right to elect product groupings under the DISC and FSC regulations, grouped its export sales by airplane program, and determined its costs, including R&D costs, for each airplane program. Under the DISC regulations, Boeing's determination properly allocated definitely related expenses to its export sales and was also consistent with the general rule of Treas. Reg. § 1.861-8(a)(2), which provides that "allocations and apportionments are made on the basis of the factual relationship of deductions to gross income."

   The government disagreed with Boeing's approach, not on the grounds that it had failed to establish a direct link to support its allocation, but rather on the grounds that Treas. Reg. § 1.861-8(e)(3) applies certain mechanical rules for allocating R&D expenses. Although the district court held that Treas. Reg. § 1.861-8(e)(3) was invalid as applied to the CTI calculation, the Ninth Circuit concluded that in computing the company's net income, the Commissioner "properly applied Treas. Reg. § 1.861-8(e)(3) to allocate Boeing's R&D costs to its export sales." App. at 2a. (2) The court's conclusion is wrong as a matter of law.

   Amicus TEI submits that Treas Reg. § 1.861-8(e)(3)'s requirement that a taxpayer allocate R&D expenses to sales revenues within a single two-digit SIC code vitiates the flexibility taxpayers have under the DISC statute to claim congressionally provided tax benefits. The section 861 regulations were tailored for the purpose of allocating and apportioning income and expenses between foreign and domestic sources under the foreign tax credit provisions of the Code. The mechanical rules of Treas. Reg. § 1.861-8(e)(3) impermissibly conflict with the more specific DISC regulations, which accord taxpayers a choice in grouping sales according to product lines. Because Treas. Reg. § 1.861-8(e)(3) cannot be harmonized with the purposes of the DISC provisions, it is invalid as applied to DISCs.

2. Congress enacted the DISC and FSC provisions to provide a more level playing field for U.S. companies competing in foreign markets. The DISC provisions were enacted at a time when the economy was doing poorly. The Nixon Administration determined that tax changes were needed as part of a balanced program of stimulation and stability. The changes were designed not only to stimulate spending but also to provide more jobs in the United States. Congress agreed, stressing the importance of providing tax incentives for U.S. firms to increase their international business not only because of their stimulative effect, but also to remove a disadvantage to U.S. businesses engaged in export activities through domestic subsidiaries. The Revenue Act of 1971 contained the DISC provisions, which were intended to provide a broad incentive program for taxpayers.

   In establishing the DISC regime, Congress created a statutory scheme that was clearly intended to permit DISCs to earn profits in excess of those earned under the arm's-length pricing rules otherwise used between related parties. Thus, Congress established a unique regime under which taxpayers using DISCs were to obtain benefits not ordinarily then available.

3. There are two primary reasons why Treas. Reg. § 1.861-8(e)(3) should not be applied to the calculation of CTI. First, Congress intended only that the general principles of section 861 should apply in the DISC context. Second, the special allocation rule of Treas. Reg. § 1.861-8(e)(3) does not further those principles in this context.

   1. Computing CTI requires allocating costs to gross receipts and, in the first instance, requires allocating costs to the gross receipts to which they definitely relate. If costs are not definitely related to certain receipts, they are apportioned among income on a ratable basis. Congress provided that these allocations and apportionments are to be "determined in a manner consistent with the rules set forth in § 1.861-8." The DISC regulation --Treas. Reg. § 1.994-1(c)(6)(iii)--implements this legislative history by providing that CTI should be determined "generally in accordance with the principles applicable under section 861."

      What is abundantly clear is that the regulation implementing the DISC provisions and governing the allocation of costs for CTI purposes, as well as the legislative history of the DISC provisions, express respect for the section 861 principles, but go no further. The DISC rules contemplate "consistency." The legislative history contemplates applying generally the "principles" of section 861. In each case, the goal of the statute is to determine CTI so that actual circumstances are reflected. The government's attempt to rigidly apply rules crafted under section 861 for another purpose is unsupportable and distortive.

      The Code's sourcing rules "undertake to classify the sources of income within the United States by the nature and location of the activities of the taxpayer or his property which produces income." Commissioner v. Ferro-Enamel Corp., 134 F.2d 564, 566 (6th Cir. 1943). The rules have been a part of the tax law almost since the beginning of the modern income tax. Treas. Reg. § 1.861-8 provides some general and some mechanical guidance for allocating and apportioning deductions. From a general perspective--consistent with the DISC regulations--there must be a factual relationship between the deduction and the class of gross income under Treas. Reg. [subsection] 8 1.861-8(a)(2), -8(b)(2). If a deduction cannot be identified with any specific class of gross income, it will generally be apportioned among all of the taxpayer's gross income. Treas. Reg. § 1.861-8(b)(5). Boeing's allocations were consistent with these general rules.

      That the DISC legislative history and regulations incorporate consistency with the general section 861 principles into the CTI calculation does not...