DocketNumber: No. 442-75
Citation Numbers: 220 Ct. Cl. 76, 599 F.2d 400
Judges: Davis, Kashiwa, Kunzig
Filed Date: 4/18/1979
Status: Precedential
Modified Date: 1/13/2023
delivered the opinion of the court:
This case revolves around the application of the foreign-income exclusion provided by section 911 of the Internal Revenue Code, 26 U.S.C. § 911, to the work of an American artist residing and creating abroad. Plaintiff Robert H. Cook, a United States citizen, is a sculptor, long-resident in Rome, Italy, who works in bronze.
For both 1970 and 1971 taxpayer’s income tax returns excluded part of his income as foreign earned income under
Taxpayer paid the additional amounts found due by the Service, and then filed timely refund claims for both years. These claims stated that in light of the Tax Court’s decision in Tobey v. Commissioner, 60 T.C. 227 (1973) acq. 1979-10 I.R.B. at 6,
I.
At the center of the case is section 911(a), providing for the exclusion of foreign income if three general conditions are satisfied: (1) taxpayer must be either a bona fide foreign resident [§ 911(a)(1)] or physically present abroad for 510 days [§ 911(a)(2)]; (2) the income received must be "from sources without the United States”; (3) the income received must constitute "earned income attributable to services performed” during foreign residency.
The currently disputed issues are these: (a) Is taxpayer correct that he is entitled to calculate his net earned income and then deduct his foreign income exclusion of $25,000? (b) Is the defendant right that a large part of plaintiffs income from his work was not "from sources without the United States”? (c) Is taxpayer bound, because of the nature and wording of his refund claims, by the figures and factual statements set forth in his returns for the two taxable years? and (d) Was capital a "material income-producing factor” for plaintiffs income? In the subsequent sections of this opinion, we answer the first three of these questions, and find it unnecessary to delve into the fourth; we also compute, on the basis of our analysis of the substantive issues taken together with the facts which have to be accepted on these motions, the amount of the taxes owed for each of the two taxable years.
In claiming an exclusion under section 911(a), taxpayer argues that he is entitled to exclude his foreign source income from net income. Plaintiff would subtract his business expenses from gross receipts to arrive at a figure labeled "Schedule C Net Earned Income.” From this net income figure taxpayer would then subtract his excludable foreign income, without any reduction for expenses alloca-ble to the foreign income.
We reject this attempt to compute an exclusion from net income as contrary to the statute, as it has been implemented by regulations, revenue rulings, and case law. Section 911(a) begins with the statement that "[t]he following items shall not be included in gross income and shall be exempt from taxation under this subtitle * * *” (emphasis added). This language, together with the last sentence of section 911(a) (precluding deductions from gross income when such deductions are "properly allocable to * * * amounts excluded from gross income under this subsection”) tends to suggest, at least for individual taxpayers, that the section 911 exclusion is to be computed on the basis of gross income.
The tilt of the statutory language is strongly reinforced by the interpretative regulations, in effect since 1963, relating to individuals. See Treas. Reg. 1.911-2(a)(l) ("amounts constituting earned income * * * shall be excluded from the gross income of an individual * * *”) (emphasis added); id. at (a)(4) (specifying the maximum amount to be "excluded from the gross income of an individual”) (emphasis added). See also Rev. Rul. 75-86, 1975-1 Cum. Bull. 242 (example number one). The cases which have discussed the section 911 exclusion for individuals also calculate the exclusion from the taxpayer’s gross income. See e.g., Brewster v. Commissioner, 473 F.2d 160 (D.C. Cir. 1972) (per curiam), aff’g 55 T.C. 251 (1970); Tobey v. Commissioner, 60 T.C. 227 (1973); Brewster v. Commissioner, 67 T.C. 352 (1976), aff’d, 607 F. 2d 1369, cert. denied, 444 U.S. 991 (1979).
Here, taxpayer is clearly reporting on an individual basis, and has not shown (or even argued) that the Service had any long-standing administrative policy allowing individuals to exclude foreign source income from a net figure. The contrary is clearly true, and there is therefore no reason to reject the facial suggestion of the statute that gross income is to be the starting point.
III.
A precondition for a section 911 exclusion is that the income received be "from sources without the United
We agree with plaintiff that the rationale of Tobey v. Commissioner, 60 T.C. 227 (1973) (reviewed by the court) acq. 1979-10 I.R.B. at 6, compels the conclusion that Mr. Cook’s sales be deemed "personal services” under the sourcing rules. Tobey did not directly deal with the proper sourcing of that artist’s income,
In this case the respondent [the Commissioner] has created a colorful fabric of definition and illustrations to enhance his argument that petitioner is making "products” rather than producing "earned income” by his personal efforts in creating his paintings. We view this argument as untenable. * * * * The concept of the artist*84 as not "earning” his income for the purposes of section 911 would place him in an unfavorable light. * * * To avoid discriminatory treatment, we perceive no sound reasons for treating income earned by the personal efforts, skill, and creativity of a Tobey or a Picasso any differently from the income earned by a confidence man, a brain surgeon, a movie star, or, for that matter, a tax attorney. 60 T.C. at 235
See generally, Note, Robida & Tobey: The New Test for Section 911 "Earned Income,” 27 Tax Law. 493, 498-500 (1974) (Tobey clearly rejected the "product test” for determining earned income).
To hold now that (as defendant urges) Congress intended to allow an exclusion of foreign-source income earned through personal efforts under 911 but to limit that exclusion by treating the outcome of personal efforts as "personal property” under the sourcing rules would gut the Tobey decision and produce an internally inconsistent application of the statutory pattern. In an effort to avoid the implications of Tobey, defendant argues that the sourcing rules provide different, narrower definitions of "personal property” and "personal services” than the 911 use of "earned income.” What defendant cannot avoid, however, is that an application of the sourcing rules under section 911 which would create an absolute distinction between labor and the tangible results of that labor — a distinction squarely rejected by Tobey for section 911— would be to attribute to Congress an inconsistent and self-contradictory purpose.
Furthermore, defendant’s reading would create artificial and technical distinctions without genuine substantive foundation. That interpretation of the sourcing rules requires that, after defining the artist’s work as "personal property,” a second determination be made under state law — where the sale took place. See I.R.C. § 863(b)(2) (specifying sourcing rule for "personal property” which was produced without and "sold within the United States”) (emphasis added). Because the Uniform Commercial Code provisions on the sale of goods
IV.
Thus, taxpayer meets three basic conditions for exclusion of income under section 911: he is conceded to be a bona fide foreign resident under 911(a)(1) (part I, supra); his income is derived (with the exception of some business days he spent in the United States in 1970) from "without the United States,” as demonstrated in part III, supra; and his income for both his commissioned and noncommissioned sales is conceded to be "earned income” under the Tobey holding (part I, supra). We have also ruled above that the $25,000 foreign income exclusion is to be computed on the basis of taxpayer’s gross income (not his net income). See
We hold that because of the nature of his refund claims taxpayer cannot now contest the figures and statements in his own returns (though of course the Government can do so). His refund claims twice emphasized that his original returns should be accepted as filed and without adjustment.
The substantial variance rule is based on section 7422(a) which requires a refund claim to be "duly filed” with the Internal Revenue Service before maintaining a lawsuit for a tax refund. Regulation section 301.6402-2(b) states one of the requirements for a "duly filed” refund claim:
The claim must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof.
Treas. Reg. § 301.6402-2(b)(l) (1971).
This regulation and its predecessors have long been interpreted as barring a subsequent refund suit which presents claims at "substantial variance” with those presented in the refund claim. See, e.g., United States v. Felt & Tarrant Mfg. Co., 283 U.S. 269 (1931); Real Estate-Land Title & Trust Co. v. United States, 309 U.S. 13, 17-18 (1940); Fruehauf Corp. v. United States, 201 Ct. Cl. 366, 378-79, 477 F.2d 568, 574-75 (1973). Although many cases (including those cited) found a substantial variance based
V.
In this segment of our opinion, we concern ourselves with the proper tax for 1970. Although taxpayer’s original return for 1970 listed gross business income ("gross receipts” or "gross sales” of line 1, schedule C, Form 1040, 1970 edition) as $36,107, this amount was readjusted during the Service audit to the figure of $48,506.99. (The latter figure is a total of some $20,006.99 in noncommis-sioned sales and $28,500 in receipts from the Rudin commission.) Defendant is, of course, entitled to challenge the figure in plaintiffs return and to use its own figure of $48,506.99. We adopt the latter, on these cross-motions for
Another factual assumption we make is that Mr. Cook spent 67 business days in the United States during 1970. That is what he stated in his return and in effect reaffirmed in his refund claim (as explained in part IV, supra). He now says that most, perhaps all, of those 67 days should not be counted as "work” days. This change in factual position from his refund claim is impermissible, for the reasons given in part IV, supra. Having claimed and reclaimed a deduction of business expenses for 67 days in the United States, he cannot now say that he spent a lesser number of days for the purposes of the present case.
Given our factual assumptions, the computations set forth in Appendix A, infra, show that for 1970 taxpayer is entitled to no refund. In fact, he would owe the Government a small amount of money, but defendant has interposed no counterclaim. We add that, even if taxpayer is not precluded from varying the number of work or business days he spent in the United States in 1970, it would not affect the outcome for that year.
Our computation of taxpayer’s liability for 1971 rests on two factual assumptions — that taxpayer’s gross business income for 1971 was $27,772 and that the $12,250 taxpayer received in 1971 on the Rudin commission was for work done in 1970. Plaintiffs original return for 1971 listed $15,522 in noncommissioned sales, and $12,250 in commissioned receipts (i.e. the Rudin commission), for a total of $27,772. Plaintiffs refund claim for 1971 stated that this return "should have been accpted [sic] without adjustment.” See note 10, supra. In his reply brief taxpayer now contends that the actual amount of commissioned receipts in 1971 was only $10,000, for a total gross business income of $25,522. This new factual contention is barred by the substantial variance rule, discussed in part IV, supra. Taxpayer is also bound to the factual assertion in his original return, reiterated in the refund claim, that the $12,250 received in 1971 for the Rudin sculpture was paid for services rendered in 1970. On that premise, section 911(c)(2) mandates that, in applying the $25,000 maximum income exclusion, "* * * amounts received shall be considered received in the taxable year in which the services to which the amounts are attributable are performed.” Because the taxpayer has already received the maximum statutory exclusion of $25,000 for 1970, see part V, supra, and appendix A, infra, he cannot exclude any of the $12,250 which is attributable to the 1970 tax year. See Treas. Reg. § 1.911-2(d)(l) (1971); Tax Guide por U.S. Citizens Abroad 11-12 (I.R.S. Public. No. 54, 1971 ed.).
We do not assume that taxpayer is precluded from calculating his 1971 tax liability by excluding his noncom-missioned receipts for that year as foreign-sourced income. Defendant strenuously contends that taxpayer cannot now exclude any of the 1971 noncommissioned sales because
With these assumptions, our computations for 1971, contained in appendix B, infra, reveal that taxpayer is entitled to a refund of only $40.46.
VII.
There is still another theory, pressed by defendant, under which taxpayer could be denied recovery of even this $40.46. The Government observes that Mr. Cook used expensive bronze materials to produce his sculptures,
Conclusion
On these grounds, the plaintiffs motion for summary judgment is denied as to 1970 and granted as to 1971 in the sum of $40.46. Defendant’s motion for summary judgment is granted as to 1970 and denied (to the extent of $40.46) as to 1971. Judgment is entered for plaintiff in the sum of forty dollars and forty-six cents ($40.46), plus interest thereon as provided by law.
Plaintiff Joan M. Cook, his wife and also a U.S. citizen, is a party only because the couple filed joint income tax returns for 1970 and 1971, the taxable years. We shall refer to Mr. Cook as the taxpayer or plaintiff.
Noncommissioned sales are those made after the sculpture is completed, usually but not always from art galleries where the works are displayed and placed on sale. Commissioned sales are ordered in advance by the purchaser and then created “to order.”
Taxpayer received payments on the Rudin commission in both 1970 and 1971.
Holding, in the case of the well-known painter Mark Tobey, that income from noncommissioned sales in the United States was “earned income” (not income from the sale of a product) for the purposes of the section 911 exclusion of foreign "earned income.”
The then-existing section 911(a) read as follows:
(a) General rule.
The following items shall not be included in gross income and shall be exempt from*80 taxation under this subtitle:
(1) Bona fide resident of foreign country.
In the case of an individual citizen of the United States who establishes to the satisfaction of the Secretary or his delegate that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such uninterrupted period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c).
(2) Presence in foreign country for 17 months.
In the case of an individual citizen of the United States who during any period of 18 consecutive months is present in a foreign country or countries during at least 510 full days in such period, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such 18-month period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c).
An individual shall not be allowed as a deduction from his gross income, any deductions (other than those allowed by section 151, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this subsection. 26 U.S.C. § 911(a) (1970).
We recognize that the statutory language is not wholly free from ambiguity. See Vogt v. United States, 210 Ct. Cl. 246, 252-57, 537 F.2d 405, 409-12 (1976). See also our discussion of the Vogt case infra.
No sourcing issue was raised there, possibly because that taxpayer had considerably more than $25,000 in foreign earnings. See 60 T.C. at 230.
Defendant’s brief assumes that, if the artist’s products are "personal property” under tax sourcing rules, such products are also "goods” covered by Article 2 of the
The same type of artificial result, depending on the technical provisions of a contract, was also rejected by the Tax Court in Tobey. Faced with the Service’s attempt in Tobey to distinguish between art works created under a contract (for which the Service would allow a 911 exclusion) and art works not created under a specific contract (for which the Service would not allow an exclusion) the court said:
"It is plain that the character of the income does not depend upon a mechanical reading of the terms of a contract or upon the existence or nonexistence of an end product — which is, after all, an arbitrary criterion.” 60 T.C. at 235.
The complete text of the refund claim in part II of the 1040X form was identical for both 1970 and 1971 and read as follows:
Tax examiner (Mr. Skorupinski) in Rome did not allow section 911 exclusion on all work performed by taxpayer in Rome. On [sic] light of the recent court decision "Mark Tobey v. Commissioner” (copy enclosed) the original return filed by the taxpayer should have been accepted without adjustment. Therefore this amended return is to re-file the 1970 and 1971 returns as originally filed (copies enclosed).
Union Pacific said that the requirement of an adequate refund claim "is designed both to prevent surprise and to give adequate notice to the Service of the nature of the claim and the specific facts upon which it is predicated, thereby permitting an administrative investigation and determination. United States v. Memphis Cotton Oil Co., 288 U.S. 62 (1933). In addition, the Commissioner is provided with an opportunity to correct any errors, and if disagreement remains, to limit the scope of any ensuing litigation to those issues which have been examined and which he is willing to defend.” (Citations omitted). 182 Ct. Cl. at 109, 389 F.2d at 442.
Plaintiff does not deny that he actually spent 67 days in the United States. Rather, his contention seems to be that the 67 days were spent in this country on gallery and public relations "business” (and some on family travel), not on his actual sculpture "work” which he performed solely in Italy. He seems to consider only his actual sculpturing to be important for our purposes, though his 67 days in this country were related to selling his art work, procuring commissions, and furthering his profession of sculpture.
Although taxpayer under his theory (no "work days” spent in the United States) would be able to claim the entire amount of his income as foreign source income, he could not exclude that income above the then-statutory maximum of $25,000. See I.R.C. § 911(c)(1)(B) (1970). Taxpayer is eligible to exclude the maximum amount even taking into account the 67 "business” days. This proposition is demonstrated as follows:
Court's method
1) allocation of income between days in U.S. and days abroad:
67/240 X $48,506.99 = $13,541.53 (U.S. source income)
173/240 X $48,506.99 = $34,965.46 (foreign source income)
*89 2)gross business income: $48,506.99
3)gross business income less excludable foreign income (up to $25,000 maximum): $48,506.99 ($25,000.00)
4)gross includable business income: $23,S06.99
*88 Taxpayer's method
1) no allocation necessary, all days for working spent abroad:
(foreign source income) $48,506.99
*89 2)gross business income: $48,506.99
3)gross business income less excludable foreign income (up to $25,000 maximum): $48,506.99 ($25,000.00)
4)gross includable business income: $23,506.99
Plaintiff made no trips to the United States in 1971.
Taxpayer’s return for 1970 claimed some $16,000 in bronze-casting expenses and
This sentence read:
"In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, under regulations prescribed by the Secretary or his delegate, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income.” 26 U.S.C. § 911(b) (1970).
In Tobey — which involved paintings, pictures, and drawings, using relatively inexpensive materials — it was stipulated that capital was not a material income-producing factor. 60 T.C. at 229.
If defendant feels that it should not have to pay this $40.46 (plus interest) without further proceedings on this issue, it may make that view known to the court in a motion for rehearing.
This allocation of the source of income for personal services is done pursuant to Treas. Reg. § 1.861-40?); see Tax Guide for U.S. Citizens Abroad 12-13 (I.R.S. Public. No. 54, 1971 ed.); Rev. Rul. 69-238, 1969-1 Cum. Bull. 195; Hagerty v. Commissioner, 42 T.C.M. (P-H) ¶ 73,162 at 769 (1973).
The $4,979.00 figure is from taxpayer’s 1971 return on a supplementary schedule for Form 2555. Taxpayer listed this figure as "expenses incurred on commission only,” and thus the only business expenses which he can deduct are these expenses allocable to his included income. See I.R.C. § 911(a); Tax Guide for U.S. Citizens Abroad 16 (I.R.S. Public. No. 54, 1971 ed.).