APPEAL FROM THE DISTRICT COURT OF THE VIRGIN ISLANDS, DIVISION OF ST. THOMAS AND ST. JOHN (D.C. Civil No. 334-1971)
Maris, Gibbons and Weis, Circuit Judges.
The question presented by this appeal is whether the taxpayer, Great Cruz Bay, Inc., a Virgin Islands corporation, is entitled to elect Virgin Islands income tax treatment as a small business corporation under subchapter S of the Internal Revenue Code, 26 U.S.C. § 1371 et seq. For the purposes of subchapter S, section 1371(a) of the Code defines a small business corporation to mean a domestic corporation which does not, inter alia, "(3) have a nonresident alien as a shareholder". The answer turns on whether, under the income tax law as applied in the Virgin Islands, a United States citizen residing in the continental United States is to be deemed a "nonresident alien" within the meaning of the above quoted provision of section 1371(a) (3).
The taxpayer-corporation was organized under the laws of the Virgin Islands. It filed its election with the Tax Division of the Department of Finance of the Government of the Virgin Islands to be taxed for the fiscal years 1968, 1969 and 1970 as a small business corporation and it computed its Virgin Islands income tax liability accordingly. The Commissioner denied the taxpayer the status of a small business corporation because three of its shareholders were United States citizens not residing in the Virgin Islands and he determined a deficiency in tax on the ground that those stockholders were nonresident aliens for Virgin Islands income tax purposes within the meaning of section 1371(a) (3) of the Internal Revenue Code.
The taxpayer filed a petition in the District Court of the Virgin Islands for the redetermination of its income tax liability. The parties stipulated that the sole question was whether the three shareholders had been correctly classified by the Commissioner as nonresident aliens, thereby disqualifying the taxpayer as a small business corporation. The taxpayer moved for summary judgment on the pleadings which was granted by the district court. The court held that the term "nonresident alien" as used in section 1371(a) (3) of the Internal Revenue Code and defined in section 1.871-2 of the Income Tax Regulations,*fn1 should be read, in applying the income tax law to the Virgin Islands, to mean "an individual whose residence is not in the Virgin Islands and who is not a citizen of the United States". The court concluded that the Commissioner had erroneously redefined that term for Virgin Islands income tax purposes when he classified the three nonresident United States citizens as nonresident aliens of the Virgin Islands. The court stated that if the interpretation of the Commissioner were allowed to stand, the territory would be claiming a larger tax than the United States would have collected in the absence of the mirror system. Moreover, the court stated, it could not view as a non-substantive change in nomenclature the characterization of a United States citizen residing in any state or territory of the United States as a nonresident alien for this or any other taxing purposes. Accordingly, the determination of the Commissioner was reversed.
This appeal by the Commissioner followed. The Commissioner contends that his action in classifying as nonresident aliens the United States citizens residing in the United States was consistent with the separate territorial income tax structure provided by Congress for the Virgin Islands. The United States as amicus curiae supports the Commissioner's determination and urges that the decision of the district court is erroneous and should be reversed.
This court had occasion in Dudley v. Commissioner of Internal Revenue, 1958, 3 Cir., 258 F.2d 182, and again in Chicago Bridge and Iron Company v. Wheatley, 1970, 3rd Cir., 430 F.2d 973, to discuss the Virgin Islands income tax structure as established by the Naval Appropriation Act of 1922, approved July 12, 1921, 42 Stat. 123, 48 U.S.C.A. § 1397.*fn2 The effect of this statute was to create a separate territorial income tax which was to be collected by the Government of the Virgin Islands, applying the provisions of the United States income tax laws mutatis mutandis under what has been called the "mirror" theory. By section 28(a) of the Revised Organic Act of 1954, the permanent residents of the Virgin Islands were required to pay their taxes on income from all sources, both within and outside the Virgin Islands, into the treasury of the Virgin Islands. 48 U.S.CA. § 1642. United States citizens not residing permanently in the Virgin Islands were required to file two tax returns, one reporting and paying taxes to the Virgin Islands on Virgin Islands income and the other reporting and paying taxes to the United States on income from all sources, with a credit for taxes paid to the Virgin Islands.*fn3
In Dudley v. Commissioner of Internal Revenue we said:
"The tax thus imposed by the Naval Appropriation Act was explained in Congress as providing for local imposition upon the inhabitants of the Virgin Islands of a territorial income tax, payable directly into the Virgin Islands treasury, to assist the Islands in becoming self-supporting. The enactment was recommended as following the precedent of earlier legislation applying to Puerto Rico and the Philippines. That purpose has been consistently implemented by both the federal and territorial taxing authorities, who have recognized that Congress created a local, locally collectible income tax and that the United States and the Virgin Islands are distinct taxing jurisdictions although their income tax laws arise from an identical statute applicable to each. Internal Revenue rulings, the first of which was issued over twenty years ago, have taken this view. I.T. 2946, XIV-2 C.B. 109 (1935); I.T. 3690, 1944 C.B. 164. The correctness of this official interpretation and practice appears never heretofore to have been questioned, and the income tax has been administered in the Virgin Islands in accordance with this construction for over a generation. Such a settled administrative construction applied in a multitude of cases over an extended period is entitled to great weight." 258 F.2d at p. 185.
In Chicago Bridge and Iron Company v. Wheatley the issue presented was whether a Delaware corporation was entitled to use the Western Hemisphere Trade Corporation deduction to reduce its income tax liability to the Virgin Islands.*fn4 In that case we stated:
"Both the federal tax administrators and the Congress have recognized that implementation of the Internal Revenue Code as a separate taxing statute in the Virgin Islands requires some substitution of language. In a ruling published in 1935, the Bureau of Internal Revenue noted that in construing the taxing statute applicable in the Virgin Islands, 'it will, of course, be necessary in some sections of the law to substitute the words "Virgin Islands" for the words "United States," in order to give the law proper effect in those islands. ' I.T. 2946, XIV-2 Cum. Bull. 109, 110 (1935)." 430 F.2d at p. 975.
An Office Decision by the Bureau of Internal Revenue of the United States Treasury Department published in 1935, I.T. 2946, XIV-2 C.B. 109, referred to in both the Dudley and Chicago Bridge cases, interpreted, under the Revenue Act of 1934, the status of a citizen of the United States in the Virgin Islands with ...