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Danbury Inc. v. Olive

filed: June 5, 1987.

DANBURY, INC., APPELLEE
v.
ANTHONY OLIVE, DIRECTOR BUREAU OF INTERNAL REVENUE GOVERNMENT OF THE VIRGIN ISLANDS, APPELLANT



On Appeal from the United States District Court of the Virgin Islands, Division of St. Croix, Civil Action No. 85-269.

Author: Stapleton

BEFORE: SLOVITER, STAPLETON, and ROSENN, Circuit Judges.

STAPLETON, J., Circuit Judge

Danbury, Inc. ("Danbury") a Nevada corporation that maintains its sole office in the Virgin Islands, instituted this litigation by filing a "Petition for Redetermination of Alleged Income Tax Deficiency" in the District Court of the Virgin Islands. The Virgin Islands' Bureau of Internal Revenue ("the BIR") appeals from a January 24, 1986, district court decision that granted summary judgment to Danbury.

The district court erroneously concluded that the tax law then applicable in the Virgin Islands to a corporation such as Danbury did not support the deficiencies alleged by the BIR. Furthermore, on October 22, 1986, the Tax Reform Act of 1986 ("the Tax Reform Act") became law. We will reverse and remand the case for consideration of whether the tax years at issue here, 1981 and 1982, are "pre-1987 open years" for Danbury, as that phrase is used in the Tax Reform Act.

I.

The facts underlying this dispute are simple and uncontested. Danbury is a holding company for the investments of its two shareholders. Although incorporated under the laws of Nevada, Danbury keeps all its corporate documents at its sole office in the Virgin Islands, maintains a Virgin Islands bank account, and holds all its shareholders' and directors' meetings in the islands.

On September 15, 1982, Danbury filed its income tax return for the year 1981 with the BIR, disclosing income of $256,118. The corporation paid no tax. On July 1, 1983, Danbury filed its return for the year 1982 with the BIR, disclosing "taxable income" of $96,985 and other income of $526,057.55. Danbury paid the BIR $26,243. The income on which Danbury did not pay tax, $256,118 in 1981 and $526,057.55 in 1982, came from sources outside the Virgin Islands that were not part of a Virgin Islands trade or business. Danbury did not file an income tax return for either 1981 or 1982 with the Internal Revenue Service of the United States.

On September 4, 1985, the BIR notified Danbury that it had found a $97,750 tax deficiency for 1981 and a $240,607 deficiency for 1982. The deficiency notice referred Danbury to 48 U.S.C. section 1642, stating that under this statute "foreign corporations such as yourself are taxed just as if you were a domestic corporation and satisfy both your U.S. and V.I. income tax obligation by paying V.I. income tax on your income from all sources." App. at 14.

Pursuant to title 33, section 943(a) of the Virgin Islands Code and 28 U.S.C. section 1612(a), Danbury filed suit in the District Court of the Virgin Islands to contest the asserted deficiencies. Danbury's complaint claimed that no additional tax was due because the applicable tax statute did not require it to pay tax on its income from sources outside the Virgin Islands and because collection of additional tax by the BIR was barred by waiver, estoppel, and limitations. Danbury apparently dropped its waiver, estoppel, and limitations arguments during oral argument in the district court. The district court decided the remaining issue on cross-motions for summary judgment. See Danbury Inc. v. Olive, 627 F. Supp. 513 (D.V.I. 1986).

II.

To understand the particular statutory provisions relevant here, one must have some general knowledge of the evolution of income tax law in the Virgin Islands since Denmark ceded the islands to the United States in 1917. At the outset, therefore, we briefly describe this evolution.

An act of Congress in 1917 continued the force and effect of all local laws imposing taxes, so far as compatible with the change in sovereignty, until Congress provided otherwise. Act of Mar. 3, 1917, ch. 171, § 4, 39 Stat. 1133 (codified as amended at 48 U.S.C.A. § 1395 (West 1952)). Then in the Naval Appropriations Act of 1921, Congress declared that the income tax laws of the United States also constitute the income tax laws of the Virgin Islands, with the proceeds from the laws, when they function as Virgin Islands laws, to be paid into the treasury of the Virgin Islands rather than the treasury of the United States. Naval Appropriations Act of 1921, ch. 44, § 1, 42 Stat. 123 (codified as amended at 48 U.S.C.A. § 1397 (West Supp. 1987)); see also V.I. Code Ann., tit. 33, § 1931 (15) (1967). This 1921 statute set up the "mirror tax" system that remains in use: "Virgin Islands" is in effect substituted for "united States" (and vice versa) in the Internal Revenue Code so that, to satisfy Virgin Islands tax obligations, an individual or corporation in the Virgin Islands pays taxes to the BIR equivalent to the taxes an individual or corporation under the same circumstances in the United States would pay to the Internal Revenue Service. See, e.g., HMW Industries, Inc. v. Wheatley, 504 F.2d 146, 150 (3d Cir. 1974) (Congress "create[d] a separate taxing structure for the Virgin Islands 'mirroring' the provisions of the federal tax code except as to those provisions which are incompatible with such a separate tax structure"); Vitco, Inc. v. Government of Virgin Islands, 560 F.2d 180, 185 (3d Cir. 1977) (substantive equality of treatment between mainland taxpayer and Virgin Islands taxpayer is goal or mirror system), cert. denied, 435 U.S. 980, 98 S. Ct. 1630, 56 L. Ed. 2d 72 (1978).

The U.S. Treasury Department and the Internal Revenue Service did not immediately implement the mirror system despite the clear language of the 1921 statute. Until 1935, these agencies treated the Virgin Islands as a "collection district" for United States taxes, rather than recognizing the distinct tax jurisdiction that the islands constitute according to the Naval Appropriations Act. See I.T. 1454, I-2 C.B. 180 (1922), revoked by I.T. 2946, XIV-2 C.B. 109 (1935). Under the collection district approach, all taxpayers with attachments to both locations filed only one return, either in the Virgin Islands or the United States, depending upon where the taxpayer resided on the last day of the tax year.

When the mirror system was actually implemented in 1935, some taxpayers were required to file two returns. For example, a corporation considered "domestic" in the United States but doing business as a foreign corporation in the Virgin Islands was required to submit a return to the BIR, paying tax on income from sources in the Virgin Islands, and to submit a return to the Internal Revenue Service, paying tax on worldwide income, with a foreign tax credit allowed for the tax paid to the Virgin Islands. The mirror system, with its two separate taxing jurisdictions, operated similarly for citizens of the United states who resided in the Virgin Islands. Cf. Chicago Bridge & Iron Co. v. Wheatley, 430 F.2d 973, 974 & n. 1 (3d Cir. 1970) (even after 1954, non-inhabitant U.S. citizens or U.S.-chartered corporations that earned income from a source in the Virgin Islands were required to file two returns; situation changed in 1954 for permanent residents), cert. denied, 401 U.S. 910, 91 S. Ct. 873, 27 L. Ed. 2d 809 (1971). Section 28(a) of the 1954 Revised Organic Act of the Virgin Islands ("Section 28(a)") altered the post-1935 administration of the tax laws as follows:

The proceeds of customs duties, the proceeds of the United states income tax, the proceeds of any taxes levied by the Congress on the inhabitants of the Virgin Islands, and the proceeds of all quarantine, passport, immigration, and naturalization fees collected in the Virgin Islands . . . shall be covered into the treasury of the Virgin Islands, and shall be available for expenditure as the Legislature of the Virgin Islands may provide: Provided, That the term "inhabitants of the Virgin Islands" as used in this section shall include all persons whose permanent residence is in the Virgin Islands, and such persons shall satisfy their income tax obligations under the applicable taxing statutes of the United States by paying their tax on income derived from all sources both within and outside the Virgin Islands into the treasury of the Virgin Islands . . .

Revised Organic Act of the Virgin Islands, ch. 558, § 28(a), 68 Stat. 508 (1954) (codified as amended at 48 U.S.C.A. § 1642 (West Supp. 1987)). In addition, congress in 1954 enacted a section of the Internal Revenue code that established:

For purposes of this title . . . section 28(a) of the Revised Organic Act of the Virgin Islands shall be effective as if such section had been enacted subsequent to the enactment of this title.

26 U.S.C.A. § 7651(5)(B) (West 1967) (current version at 26 U.S.C.A. § 7651(5)(B) (West Supp. 1987)). These statutory provisions brought the relevant law to the point where it stood at the time of the district court's decision. We parse Section 28(a) and 26 U.S.C. § 7651(5)(B) below.

III.

An appeal from a summary judgment triggers plenary review by the court of appeals. See Koshatka v. Philadelphia Newspapers, Inc., 762 F.2d 329, 333 (3d Cir. 1985). Our analysis begins with an application of the law in effect when the lower court granted summary judgment to Danbury. We will then turn to the impact of the Tax Reform Act.

Danbury's identity determines the tax laws that apply to the corporation. First, Danbury is a "domestic" corporation with respect to the tax laws of the United States, the non-mirrored Internal Revenue Code. See 26 U.S.C.A. § 7701(a)(4) (West Supp. 1987) ("'domestic' when applied to a corporation . . . means created or organized in the United States or under the law of the United States or of any State"). With respect to the tax laws of the Virgin Islands, the mirrored Internal Revenue Code, Danbury is a "foreign" corporation. See Vitco, Inc. v. Government of Virgin Islands, 560 F.2d 180, 181 (3d Cir. 1977) (New York corporation is "foreign' for Virgin Islands tax purposes"), cert. denied, 435 U.S. 980, 98 S. Ct. 1630, 56 L. Ed. 2d 72 (1978); Sayre & Company v. Riddell, 395 F.2d 407, 412 (9th Cir. 1968) (en banc) (under Guam's mirrored Internal Revenue Code, "a corporation organized in Guam is 'domestic'" and "a corporation organized elsewhere [i.e., in one of the United States] is 'foreign'"). Furthermore, the parties agree that Danbury qualifies as an "inhabitant" of the Virgin Islands as that term is used in Section 28(a).*fn1 This court pointed out in Vitco, supra, that "'inhabitants' ...


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