Payless Cashways, Inc. and Its Subsidiaries v. Commissioner

114 T.C. No. 3UNITED STATES TAX COURT
PAYLESS CASHWAYS, INC., AND ITS SUBSIDIARIES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26342-95. Filed February 16, 2000.
P equipped and furnished 5 of 11 floors of a
building it leased for its corporate headquarters. The
owner of the building was a limited partnership (TPS)
in which P had a 16-2/3-percent interest. TPS signed a
contract for the construction of the building on Apr.
4, 1985. P took possession of the leased space in
October 1986.
P claimed an investment tax credit for its taxable
year ending Nov. 29, 1986, for the cost of the
equipment and furnishings acquired and placed in
service at P’s corporate headquarters. R disallowed
the claimed credits.
The Tax Reform Act of 1986 (TRA), Pub. L. 99-514,
100 Stat. 2085, generally repealed the investment
credit for property acquired or placed in service after
Dec. 31, 1985. However, P’s claim for investment tax
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credit relies on transition rules contained in TRA
secs. 204(a)(7) (world headquarters rule) and
203(b)(1)(C) (equipped building rule), 100 Stat. 2156,
2144.
Held: In order for a taxpayer to have a “world
headquarters” within the meaning of TRA sec. 204(a)(7),
a taxpayer must have substantial international
operations which are directed from the headquarters.
The existence of employees stationed outside the United
States, exports or foreign source income, liability for
foreign taxes, a foreign permanent establishment, and
having foreign subsidiaries or foreign joint venture
operations are all indicia of international operations.
P did not have any of these indicia in the year in
question. P’s importation of some merchandise for
domestic sale and borrowing from banks and other
lenders who participated in the international capital
markets were not sufficient evidence of substantial
international operations to characterize P’s
headquarters as a “world headquarters” under TRA sec.
204(a)(7).
Held, further: TRA sec. 203(b)(1)(C) (equipped
building rule) requires the taxpayer claiming the
investment tax credit to have a specific written plan
and to have incurred or be committed to more than one-
half of the total cost of the equipped building by Dec.
31, 1985. P failed to establish that it had a specific
written plan, or that it had incurred or committed more
than one-half of the total cost of the equipped
building before Jan. 1, 1986, as required by TRA sec.
203(b)(1)(C).
Frederick Brook Voght, Rhonda Nesmith Crichlow, David F.
Levy, Michael E. Baillif, and Rajiv Madan, for petitioners.
Michael L. Boman, for respondent.
RUWE, Judge: Respondent determined a deficiency in
petitioners’ Federal income tax for their taxable year ending
November 29, 1986, in the amount of $240,298. The deficiency
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results from a disallowance of claimed investment tax credits
attributable to leasehold improvements, furnishings, and
equipment acquired for, and placed in service at, petitioners’
corporate headquarters during petitioners’ 1986 taxable year.
Petitioners now claim they are entitled to an investment credit
in an amount greater than claimed on their return. The sole
issue for decision is whether petitioners (hereinafter referred
to as Payless) are entitled to an investment tax credit pursuant
to one of the transition rules contained in the Tax Reform Act of
1986 (TRA), Pub. L. 99-514, 100 Stat. 2085.1 An unrelated issue
involving a claimed net operating loss carryback will require a
Rule 1552 computation.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Payless’ principal place
of business was located in Kansas City, Missouri, when the
petition was filed. Payless has had its corporate headquarters
1
The transition rules relied on are secs. 204(a)(7) (world
headquarters rule) and 203(b)(1)(C) (equipped building rule) of
the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085,
2156, 2144, respectively.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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at Two Pershing Square, 2300 Main Street, Kansas City, Missouri
(Two Pershing Square), since October 1986.
Payless is a full-line building materials supplier serving
the home improvement, maintenance, and repair market. Payless’
customers include both “do-it-yourself” customers and
professional contractors such as remodelers, residential
builders, and other similar businesses that purchase large
quantities of building materials. In the year in issue, Payless
operated 181 stores in 23 States and had 13,685 employees.
Payless’ sales for 1986 were $1,525,648,000. During 1986,
Payless purchased merchandise from approximately 3,000 different
suppliers. Payless purchased some of its merchandise, including
home improvement products, equipment, supplies, and materials
from foreign manufacturers and vendors. Beginning in 1981,
Payless purchased merchandise from foreign sources through its
import department with the assistance of various purchasing
agents. None of the purchasing agents utilized by Payless were
employees of Payless. Beginning in 1985, Payless purchased
merchandise from foreign sources through Multi-Growth, Ltd., a
limited liability company organized under the laws of Hong Kong.3
In 1986, Payless’ cost of merchandise sold was $1,041,678,000.
In 1986, Payless purchased merchandise from foreign manufacturers
3
The record does not disclose any ownership interest held by
Payless in Multi-Growth, Ltd., and petitioner did not assert any
such interest on brief.
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and vendors for sale in its stores totaling $24,924,968. This
entire amount was purchased from 28 manufacturers and vendors in
Taiwan. Prior to 1994, Payless owned no stores or other
facilities outside the United States. Before 1994, Payless had
no employees located outside the United States, except when
engaged in short-term travel.
In the 1980's, Payless acquired two companies, Knox Lumber
and Somerville Lumber. Payless ran those companies as separate
wholly owned entities with their own boards of directors,
presidents, and operating systems. Both companies had their own
subsidiary headquarters; Knox’s headquarters was in Minnesota,
and Somerville’s headquarters was in Massachusetts. Payless also
maintained regional headquarters located in Indianapolis, Dallas,
Denver, Phoenix, Houston, and Sacramento. Each regional
headquarters is managed by a regional vice president. Each of
the subsidiary and regional headquarters reports to Payless’
corporate headquarters at Two Pershing Square, which houses
Payless’ top corporate managers and staff.
Physical construction of the building that houses Payless’
corporate headquarters, Two Pershing Square, began on or about
October 15, 1984. At all relevant times, legal title to Two
Pershing Square was held by Two Pershing Square, Ltd. (TPS). TPS
was a limited partnership organized on October 15, 1984, under
the laws of the State of Missouri pursuant to an agreement
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between Trizec Properties, Inc. (Trizec), and PCI Building Corp.
(PCI), a wholly owned subsidiary of Payless. Trizec owned an 83-
1/3-percent interest in TPS, and PCI owned the remaining 16-2/3-
percent interest.4 Trizec and PCI made initial capital
contributions of $2,500,000 and $500,000, respectively. TPS
developed Two Pershing Square and operated Two Pershing Square
until November 27, 1992, at which time the partnership was
dissolved and Trizec took over ownership and operational
responsibilities. On April 4, 1985, TPS contracted with DiCarlo
Construction for the construction of Two Pershing Square
(construction contract). After April 4, 1985, DiCarlo
Construction relied on the plans incorporated by reference in the
construction contract to construct Two Pershing Square.
Payless took possession of its headquarters office space at
Two Pershing Square in October 1986. Payless equipped,
furnished, and leased parts of 5 of 11 floors in the building.
Under the terms of the lease, Payless was initially obligated to
rent approximately 41 percent of the office space at Two Pershing
Square and was entitled to exercise options in the future to
lease the additional office space above the first floor in that
building.
4
The record does not definitively disclose whether PCI was a
limited or general partner in the TPS partnership. Trizec,
however, executed Payless’ lease agreement as the general partner
of TPS.
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In 1993, Payless agreed to an incorporated joint venture
with Grupo Industrial Alfa, S.A. de C.V. (Alfa), a Mexican
company. Alfa and Payless agreed to establish and operate stores
selling home improvement products in Mexico. On October 18,
1993, Payless and Alfa executed a shareholders agreement that
initiated the Mexican business venture. In the shareholders
agreement, Payless and Alfa agreed to capitalize Payless de
Mexico, S.A. de C.V. (Payless de Mexico) to distribute and sell
building materials and home improvement products in Mexico.
Payless held a 49-percent interest in Payless de Mexico. Payless
de Mexico planned to build a chain of 25 stores in Mexico. In a
supply agreement dated October 18, 1993, Payless agreed to supply
Payless de Mexico with merchandise and products from its
distribution centers. On December 12, 1994, Payless de Mexico
opened its first store in Monterey, Mexico. In 1995, Payless
sold its interest in Payless de Mexico to Versax, S.A. de C.V., a
subsidiary of Alfa.
OPINION
Before 1986, taxpayers who acquired certain machinery and
equipment for use in a trade or business were allowed an
investment tax credit (ITC) against income tax liability in an
amount equal to a percentage of the cost of the “qualified
property”. Secs. 38, 46, 48. TRA section 211, 100 Stat. 2166,
generally repealed the investment tax credit for property placed
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in service after December 31, 1985. The repeal was subject to a
limited number of transitional ITC rules. TRA section 204(a),
100 Stat. 2146, contains a number of specific transition rules.
There are also three general transition rules contained in TRA
section 203(b), 100 Stat. 2143.5 TRA section 211 generally
repealed the regular investment tax credit by adding section 49
to the Code. See TRA sec. 211(a). Section 49(e) provides an
exception for “transition property”, which is defined as property
placed in service after December 31, 1985, to which the
amendments made by TRA section 201, 100 Stat. 2121, do not apply.
Sec. 49(e)(1).
World Headquarters Rule
One of the transitional rules in TRA section 204(a) deals
with property used in a leased building that serves as “world
headquarters” of the lessee and its affiliates. TRA section
204(a)(7) provides:
(7) Certain Leasehold Improvements.--The
amendments made by section 201 shall not apply to any
reasonable leasehold improvements, equipment and
furnishings placed in service by a lessee or its
affiliates if--
(A) the lessee or an affiliate is the
original lessee of each building in which
such property is to be used,
5
The rules found in TRA sec. 203(b) are known as the binding
contract rule, the self-constructed property rule, and the
equipped building rule. See TRA sec. 203(b)(A), (B), and (C).
Only the equipped building rule, TRA sec. 203(b)(C), is relevant
to this case.
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(B) such lessee is obligated to lease
the building under an agreement to lease
entered into before September 26, 1985, and
such property is provided for such building,
and
(C) such buildings are to serve as world
headquarters of the lessee and its
affiliates.
For purposes of this paragraph, a corporation is an
affiliate of another corporation if both corporations
are members of a controlled group of corporations
within the meaning of section 1563(a) of the Internal
Revenue Code of 1954 without regard to section
1563(b)(2) of such Code. Such lessee shall include a
securities firm that meets the requirements of
subparagraph (A), except the lessee is obligated to
lease the building under a lease entered into on June
18, 1986.
This exception is commonly referred to as the world headquarters
rule. The requirements of the world headquarters rule are
cumulative. Payless must prove that it meets all the
requirements of subparagraphs (A), (B), and (C) in order to
qualify for an investment tax credit under this transitional
rule. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933).
Respondent argues that Payless fails to meet the
requirements of the world headquarters rule because: (1) Payless
did not lease the entire building at Two Pershing Square, and (2)
Payless’ headquarters at Two Pershing Square was not a “world
headquarters”.
TRA section 204(a)(7) contains no explicit requirement that
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the “entire” building be leased by the taxpayer to qualify for
ITC. Respondent acknowledges that his argument that the
provision implicitly contains such a requirement has been
rejected by both the District Court for the Western District of
Washington and the Court of Appeals for the Ninth Circuit in
Airborne Freight Corp. v. United States, 78 AFTR 2d 96-6272, 96-2
USTC par. 50,552 (W.D. Wash. 1996), affd. in part and revd. in
part 153 F.3d 967 (9th Cir. 1998). On this point, the Court of
Appeals stated: “There is also no requirement [in TRA section
204(a)(7)] that the whole building be leased.” 153 F.3d at 970.
As the Court of Appeals indicated, the difficulty with the
Government’s argument is that the word “entire” was not written
into the language of TRA section 204(a)(7). Id. For the same
reason, we also decline to accept this implied restriction as
part of the statute in order to restrict its application.
We must next decide whether Two Pershing Square was Payless’
“world headquarters”. There is no dispute that Two Pershing
Square was Payless’ corporate headquarters. What is in dispute
is whether Payless’ international activities were sufficient to
qualify its corporate headquarters as a “world headquarters”.
The term “world headquarters” is not defined in the relevant
TRA provisions, nor is it defined in the Code. When a word is
undefined in a statute, it is a fundamental canon of statutory
construction that it will be interpreted as taking its ordinary,
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contemporary, common meaning. See Commissioner v. Soliman, 506
U.S. 168, 174 (1993); Perrin v. United States, 444 U.S. 37, 42
(1979). In United States v. Kjellstrom, 916 F. Supp. 902 (W.D.
Wis. 1996), affd. 100 F.3d 482 (7th Cir. 1996), the District
Court rejected an argument that a limited percentage of sales
made to foreign customers qualified the taxpayer’s headquarters
as a “world headquarters”.
We believe that an essential requirement of a “world
headquarters” is that a company have substantial international
operations or intend to have such operations in the immediate
future. Having employees outside the United States is one
indicium of international operations. Other indicia of
international operations might include exports or foreign source
income, payment of foreign taxes, or the existence of a foreign
permanent establishment such as a subsidiary or joint venture
operation in a foreign country. Payless had no exports or
foreign source income. Before 1994, Payless owned no stores or
other facilities outside the United States and had no employees
located outside the United States, except when engaged in short-
term travel.
Despite having no foreign facilities or employees stationed
outside the United States and no sales outside the United States,
Payless argues that it has sufficient “international activities”
to justify classifying its headquarters as a “world
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headquarters”. Payless principally relies on three international
activities: The purchase of merchandise from foreign
manufacturers and vendors for domestic sale; the use of foreign
capital markets; and participation in an incorporated joint
venture in Mexico in 1993-95.
In the year in issue, Payless made foreign merchandise
purchases of $24,924,968 from 28 manufacturers and vendors
located in Taiwan. During that year, Payless had a total cost of
merchandise sold of $1,041,678,000. Payless’ cost of goods sold
from foreign vendors and manufacturers was less than 2.4 percent
of the total cost of goods sold in 1986. In 1985, goods
purchased from foreign manufacturers and vendors accounted for
less than 1.3 percent of Payless’ total cost of goods sold.
During Payless’ 1987 and 1988 tax years, this percentage was 2.1
percent of the total cost of goods sold.6 We do not think that
the mere purchasing of foreign-made goods directly from a foreign
6
Payless stipulated the number of foreign manufacturers and
vendors from whom it purchased merchandise, the countries in
which these manufacturers and vendors were located, and the total
amounts of foreign merchandise purchases per year. Nevertheless,
at trial some of Payless’ witnesses testified that other foreign
source merchandise was purchased, such as lumber from Canada. No
documentation of those purchases is in evidence, and the
testimony is vague as to years and amounts. However, it appears
that these items were purchased from sellers who were doing
business in the United States and had offices and distribution
facilities within the United States. Such purchases within the
United States would not transform an otherwise domestic retail
operation into a worldwide business whose headquarters would be
its “world headquarters” within the meaning of TRA sec.
204(a)(7).
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manufacturer or vendor or through foreign independent purchasing
agents in these relative quantities is a strong indicator of
substantial international operations.7 Nor do we find the fact
that lending institutions with international operations
participated in Payless’ corporate borrowing program supports a
finding that Payless had international operations.
Finally, while the words of the transition rule “such
buildings are to serve as world headquarters”, are prospective,
we find nothing in the provision itself or the legislative
history that would indicate that those words should be read so
that they include a building becoming a “world headquarters” at
some indeterminate time in the future. Assuming without deciding
that the Mexican joint venture would have justified a
classification of Two Pershing Square as Payless’ world
headquarters in 1993-95, we find the joint venture in 1993-95 to
be too remote in time to be relevant to the tax year in question.
We are of the opinion that the words “are to serve”, while
prospective, more naturally describe the intended function of the
building when first occupied by the original lessee or sometime
shortly thereafter.8
7
The fact that certain Payless employees sometimes traveled
outside the United States to facilitate these purchases, when
viewed alone or with the other facts petitioner relies on, is not
sufficient to transform Two Pershing Square into a world
headquarters.
8
It is not necessary for us to determine in this case
whether a taxpayer must have international affiliates to have a
(continued...)
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On the record before us, there is insufficient evidence of
the type of substantial international operations required to
justify classifying Payless’ corporate headquarters at Two
Pershing Square a “world headquarters” as that term is used in
TRA section 204(a)(7).
Equipped Building Rule
In the alternative, Payless argues that its expenditures
qualify for ITC under the “equipped building rule”. TRA section
203(b)(1)(C) provides:
(1) In general.--The amendments made by section
201 shall not apply to--
* * * * * * *
(C) an equipped building or plant
facility if construction has commenced as of
[December 31, 19859], pursuant to a written
specific plan and more than one-half of the
cost of such equipped building or facility
has been incurred or committed by such date.
In order to qualify for transitional relief, Payless must show
that:
(1) Construction commenced by December 31, 1985;
(2) Construction was pursuant to a written specific plan;
and
(3) More than one-half of the cost of the building,
including its machinery and equipment, was incurred or committed
8
(...continued)
world headquarters.
9
TRA sec. 211(a) amended subpt. E of pt. IV of subch. A of
ch. 1 by adding a new sec. 49. Sec. 49(e)(1)(B) substituted
“Dec. 31, 1985", for “Mar. 1, 1986", in sec. 203(b)(1)(C).
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on or before December 31, 1985.
On brief, respondent concedes that the first requirement has
been met in that construction commenced on or before December 31,
1985. However, respondent argues that Payless has failed to
prove that it meets the remaining requirements.
Payless bears the burden of proving that it qualifies for
relief under the transitional provision. See Rule 142(a); Welch
v. Helvering, 290 U.S. at 115. We agree that Payless has failed
to establish that more than one-half of the cost of the building,
including its machinery and equipment, was incurred or committed
before January 1, 1986. On brief, Payless states: “Although
actual costs for equipment and furnishings of the other 2
Pershing Square space [the 59-percent of the building not leased
by Payless] is not available, Payless’ costs were $14,812,179 for
41 percent of the building.” (Emphasis added.) H. Conf. Rept.
99-841 (Vol. II), at II-56 (1986), 1986-3 C.B. (Vol. 4) 1, 56,
states:
Where the costs incurred or committed before March 2,
1986 (January 1, 1986, for the investment tax credit)
do not equal more than half the cost of the equipped
building, each item of machinery and equipment is
treated separately for purposes of determining whether
the item qualifies for transitional relief.
Payless’ failure to establish the total cost of the building,
including its machinery and equipment, is fatal to the argument
that more than one-half of the cost of the equipped building was
committed or incurred before January 1, 1986. Without knowing
the total cost, it is logically impossible to establish that more
than one-half of that amount has been exceeded.
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Payless would not qualify for transitional relief under TRA
section 203(b)(1)(C) even if it could establish the total cost of
the building because Payless did not have a written specific plan
and did not incur or commit to more than one-half of the cost of
the equipped building.
TRA section 203(b)(1)(C) does not explicitly state whose
“written specific plan” will satisfy the requirement of the
section. However, the conference report supports the proposition
that the “written specific plan” referred to in the section must
be the plan of the taxpayer claiming the credit. The conference
report states:
Under the equipped building rule, the conference
agreement [repeal of the ITC] will not apply to
equipment and machinery to be used in the completed
building, and also incidental machinery, equipment, and
structures adjacent to the building (referred to here
as appurtenances) which are necessary to the planned
use of the building, where the following conditions are
met:
(1) The construction (or reconstruction or
erection) or acquisition of the building, machinery,
and equipment was pursuant to a specific written plan
of a taxpayer in existence on March 1, 1986 (December
31, 1985, for the investment tax credit); and
(2) More than 50 percent of the adjusted basis of
the building and the equipment and machinery to be used
in it (as contemplated by the written plan) was
attributable to property the cost of which was incurred
or committed by March 1, 1986 (December 31, 1985, for
the investment tax credit), and construction commenced
on or before March 1, 1986 (December 31, 1985, for the
investment tax credit).
The written plan for an equipped building may be
modified to a minor extent after March 1, 1986,
(December 31, 1985, for the investment tax credit) and
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the property involved may still come under this rule;
however, there cannot be substantial modification in
the plan if the equipped building rule is to apply.
The plan referred to must be a definite and specific
plan of the taxpayer that is available in written form
as evidence of the taxpayer’s intentions.
The equipped building rule can be illustrated by
an example where the taxpayer has a plan providing for
the construction of a $100,000 building * * * [H.
Conf. Rept. 99-841, supra at II-56-57, 1986-3 C.B.
(Vol. 4) at 56-57; emphasis added.]
Based on the legislative history provided in the conference
report, we think it a fair inference that Congress intended that
the taxpayer claiming the credit would be the party required to
have the relevant plan, as evidence of its intention, and that
the taxpayer be the party that “incurred or committed” more than
50 percent of the adjusted basis of the building and the
equipment to be used in it.10 We therefore hold that the
taxpayer claiming the credit under the exception contained in TRA
section 203(b)(1)(C) must be the party who has the specific
10
Payless contends that TRA sec. 203(b)(1)(C)
was designed to protect those taxpayers who, although
having committed to incur or having incurred
substantial costs toward furnishing and equipping a
building in a large scale project by the end of 1985,
did not have all the items to be included in the
completed facility reduced to a timely binding
contract.
In Payless’ view, a group of taxpayers could be amalgamated so
that as an aggregate they would achieve the required commitment.
Payless suggests no measure for what constitutes a “substantial
commitment”. Additionally, petitioners’ proposed interpretation
of the section, by logical extension, would allow the section to
be read so that a taxpayer who had committed a very minor part of
the total construction and equipping costs could claim an
investment tax credit if other taxpayers had committed more than
half the costs of the equipped building by the cutoff date.
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written plan and the party that incurred or committed more than
50 percent of the adjusted basis of the equipped building.
The specific written plan relied on by Payless is the
construction contract between TPS and DiCarlo Construction.
Under that contract TPS not Payless, incurred or committed the
construction costs for Two Pershing Square.
The TRA transitional provisions make no accommodation for
attributing costs incurred by a limited partnership to the
partners for the purpose of determining whether they have
“incurred or committed” costs. Even if such attribution were
proper, we would be unwilling to attribute to Payless more than
16.67 percent of the costs of construction, which was the extent
of Payless’ interest in the TPS, partnership. If 16.67 percent
of the construction costs of $36,600,000 claimed by Payless as
part of its precommitted costs were attributed to Payless, and
assuming we accepted Payless’ total cost of the equipped building
of $77,627,266 and Payless’ other committed costs, Payless’
commitment would amount to substantially less than 50 percent of
the total estimated cost of the equipped building on or before
December 31, 1985.11
11
(Ownership interest times cost of Two Pershing Square)
plus tenant allowance plus equipment and furnishings equals
Payless’ pre-1986 committed costs ((.167 x $36,600,000) +
$4,900,000 + $14,812,179 = $25,824,379. $25,824,379/total
estimated costs of $77,627,266 x 100 = 33.3 percent of total
(continued...)
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Payless failed to prove that it had a specific written plan
or that it “incurred or committed” more than one-half of the cost
of the “equipped building”. For the reasons stated above, we
find that Payless does not satisfy the requirements of either TRA
section 203(b)(1)(C) or TRA section 204(a)(7) and is not entitled
to the investment credit claimed on its 1986 return.
Decision will be entered
under Rule 155.
11
(...continued)
estimated costs).