The opinion of the court was delivered by: NEALON
Involved in the present action are exclusive patent license agreements between plaintiff AMP and its wholly owned foreign subsidiaries located in the Netherlands, United Kingdom, France and Italy and its affiliated subsidiaries in Mexico, Australia and Puerto Rico.
The issue presented is whether payments received by AMP in 1963, 1964, and 1965 from its foreign subsidiaries and affiliates under these agreements constitute "income from sources without the United States" for the purpose of determining AMP's allowable foreign tax credit.
This requires deciding whether the payments were royalties or proceeds from a sale. If they were royalties, then they may be used in calculating AMP's allowable foreign tax credit and AMP prevails. If the payments were proceeds from a sale, then they may not be used in calculating the allowable credit unless the sale took place outside the United States. Currently pending before the court are cross motions for summary judgment. Oral argument on the motions was held April 17, 1979 before the undersigned. The parties have agreed that, after the court renders its opinion, they will submit a proposed judgment in the proper dollar amount. Summary judgment will be granted plaintiff in accordance with the following discussion.
Under these new agreements the subsidiaries were granted exclusive licenses for the life of the patents in their respective countries.
Payments were still to be made according to a percentage of net sales of goods manufactured under the patents (generally 5%). The agreements provided that AMP had the right to terminate if the subsidiary failed to make its payments
or if it became insolvent or bankrupt. Otherwise, the new agreements, in effect, transferred all substantial rights under the patents.
All the agreements stated that they were made in Harrisburg, Pennsylvania and, except as to the contract with the Dutch subsidiary, that they were to be construed according to the laws of Pennsylvania.
Under the Internal Revenue Code (Code) United States residents and domestic corporations are subject to United States tax on worldwide income. But, because of the desire to avoid double taxation on income earned abroad and, secondarily, to encourage American foreign trade, see Commissioner of Internal Revenue v. American Metal Co., 221 F.2d 134 (2nd Cir. 1955), cert. denied, 350 U.S. 829, 76 S. Ct. 61, 100 L. Ed. 740 (1955), the Code grants a tax credit on taxes paid to foreign jurisdictions.
See note 2 supra. However, apparently in order to, inter alia, compensate for the fact that foreign jurisdictions may tax at a different rate, the Code contains a limitation on the allowable foreign tax credit. This limitation is found in 26 U.S.C. § 904(a), which, for the years in question, read:
In other words, one determines the limitation by dividing income from sources without the United States by total worldwide income and multiplying that fraction against the United States tax on total worldwide income. In its returns for the years 1963, 1964, and 1965, AMP treated the payments received from the subsidiaries under the exclusive license agreements as foreign source income (from without the United States) and, therefore, included them in the numerator of the § 904(a)(2) fraction. This treatment was disallowed by the Internal Revenue Service and taxes owed plus deficiency interest were assessed. AMP paid the proposed assessments, filed claims for refunds, and after the lapse of six months within which the claim, was not acted upon, commenced the present action.
In determining whether income is from "sources without the United States," the United States Treasury Regulations state that the principles of 26 U.S.C. §§ 861-864 (Determination of Sources of Income) shall govern.
Treas.Reg. § 1.901-2(d),T.D. 6275, 1957. Here, the applicable section is 862, which in pertinent part reads:
Income from sources without the United States. (a) Gross Income from sources without the United States:
The following items of gross income shall be treated as income from sources without the United States: . . . (4) rentals or royalties from property located without the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using without the United States patents, . . . (6) gains, profits, and income derived from the purchase of personal property within the United States and its sale without the United States.
Defendant's basic argument is (1) the grant of an exclusive right to manufacture, use, and sell the products under a patent constitutes a sale of that patent for foreign source income purposes. It is asserted that this is true regardless of the mode of payment and that it is borne out by the fact that the transactions in question have been treated as a sale for capital gains purposes. Therefore, according to defendant, the payments in question are not royalties under 26 U.S.C. § 862(a)(4), but are proceeds from sales. And (2) since a patent is personal property its sale, for source of income purposes, is governed by 26 U.S.C. § 862(a)(6), supra. It is asserted further that, in determining where the sale took place, the relevant inquiry is the place where title passed and that this inquiry is controlled here by the exclusive license agreements themselves which were last signed by AMP in Pennsylvania and which recited that they were made in Harrisburg, Pa. Therefore, defendant argues, title passed in the United States. Plaintiff counters by contending that (1) a royalty is a payment for use of a patent and since payments here are totally dependent on use, i. e., they are based on a percentage of sales, they must be regarded as royalties; (2) even if the payments are proceeds from a sale, they are still a foreign source of income; and (3) even if the place of technical passage of title is controlling at least to the European subsidiaries, the titles passed outside the United States.
In analyzing the issues here, it must be remembered that, as stated, the major point of the foreign tax credit is to relieve taxpayers of the burden of double taxation where income subject to United States tax is also taxed by foreign jurisdictions. At the oral argument, in response to a question from the court, defense counsel stated that AMP had paid foreign taxes for the years in question, presumably on the income received under the exclusive license agreements. Hence, plaintiff would be subject to double taxation if defendant's position is sustained. This fact, standing alone, does not, of course, automatically entitle plaintiff to relief, for the allowance of the credit must be authorized by the tax laws. Nevertheless, although ordinarily a tax issue is analyzed in light of the principle that Congress intends to use its powers to its full extent, tax that which it may, and therefore, impliedly, maximize the amount of taxes owed, see Commissioner of Internal Revenue v. Wodehouse, 337 U.S. 369, 378-380, 69 S. Ct. 1120, 1124, 93 L. Ed. 1419 (1949), here the issue should be analyzed in light of the fact that the purpose of the foreign tax ...