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Polychrome International Corp. v. Krigger

argued: April 26, 1993.

POLYCHROME INTERNATIONAL CORPORATION
v.
RUDOLPH E. KRIGGER, COMMISSIONER OF FINANCE, ERIC DAWSON, COMMISSIONER OF ECONOMIC DEVELOPMENT AND AGRICULTURE, GOVERNMENT OF THE VIRGIN ISLANDS CAMCO INTERNATIONAL, LIMITED V. RUDOLPH E. KRIGGER, COMMISSIONER OF FINANCE, CLEMENT MAGRAS, COMMISSIONER OF LICENSING AND CONSUMER AFFAIRS, DEREK M. HODGE, LIEUTENANT GOVERNOR, ERIC DAWSON, COMMISSIONER OF ECONOMIC DEVELOPMENT AND AGRICULTURE RUDOLPH E. KRIGGER, COMMISSIONER OF FINANCE, ERIC DAWSON, COMMISSIONER OF ECONOMIC DEVELOPMENT AND AGRICULTURE, CLEMENT MAGRAS, COMMISSIONER OF LICENSING AND CONSUMER AFFAIRS, DEREK M. HODGE, LIEUTENANT GOVERNOR, APPELLANTS IN 92-7509 POLYCHROME INTERNATIONAL CORPORATION; CAMCO INTERNATIONAL, LIMITED, APPELLANTS IN 92-7510



On Appeal from the District Court of the Virgin Islands Division of St. Thomas and St. John. (D.C. Civil No. 86-254). (D.C. Civil No. 86-255). (D.C. Civil Action Nos. 86-00254 & 86-00255).

Before: Greenberg, Scirica and Garth, Circuit Judges.

Author: Scirica

Opinion OF THE COURT

SCIRICA, Circuit Judge.

In these consolidated class actions, Polychrome International Corporation and Camco International, Ltd. challenge certain Virgin Islands statutes imposing taxes and fees on "Foreign Sales Corporations." Seeking a refund and a permanent injunction against future assessments, they claim the statutes violate the United States Constitution, as well as United States and Virgin Islands law.*fn1 On cross-motions for summary judgment, the district court granted the Government's motions on all of plaintiffs' claims except one, on which it granted summary judgment for plaintiffs. All parties appeal. We will affirm in part and reverse in part.

I.

The challenged provisions of the Virgin Islands Code were enacted in response to, and in coordination with, a special Subpart of the Internal Revenue Code (IRC) entitled "Taxation of Foreign Sales Corporations," 26 U.S.C. §§ 921-927 (1988 & Supp. 1993). As necessary background, we begin with a brief Discussion of the history, purpose, and operation of IRC §§ 921-27.

A.

In an attempt to rectify trade imbalances, Congress has, since 1972, provided tax incentives for certain corporations engaged in export activities. Originally, Congress established a system of tax deferral for "Domestic International Sales Corporations," or DISCs.*fn2 Under pressure from signatories to the General Agreement on Tariffs and Trade,*fn3 Congress supplanted this legislation in 1984 with special provisions for "Foreign Sales Corporations," or FSCs, 26 U.S.C. §§ 921-27.*fn4 See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2d Sess., at 1041-42 (CCH 1985). These provisions allow American companies to exempt part of their export income from taxation, through the use of foreign subsidiaries.

A FSC (pronounced "fisk") is a subsidiary of an American corporation, organized under the laws of any qualified foreign country or eligible U.S. possession.*fn5 Typically, a FSC either buys goods from its American parent for resale (a "buy-sell" FSC) or takes the goods as a resale agent, receiving a commission for any such resale (a "commission" FSC). See generally Boris I. Bittker & James S. Eustice, Federal Income Taxation of Corporations and Shareholders, P 17.14(3) (3d ed. 1987).

All FSCs must satisfy certain organizational and operating requirements to qualify for the IRC's partial tax exemption. In terms of organization, FSCs must have no more than 25 shareholders, have no outstanding preferred stock, maintain an office and books of account outside the U.S., have at least one non-U.S.-resident board member, and elect FSC status. IRC § 922(a). FSCs must also perform certain management functions outside the United States. See IRC §§ 924(b), (c), (d). Its directors' board meetings must comply with the laws of its home jurisdiction, and it must keep its primary bank account outside the United States. See 26 C.F.R. § 1.924(c) (1993). If the FSC satisfies these requirements, a portion of its income is exempted from taxation. See I.R.C. §§ 921(a), 923, 924; see also 26 C.F.R. § 1.923-1T(b)(1)(iii) (1993).*fn6

B.

Because FSCs are incorporated abroad, the benefits afforded by the IRC may be reduced or eliminated if FSC-host countries impose stiff taxes on FSC income. See generally Blake A. Bernet, The Foreign Sales Corporation Act: Export Incentive for U.S. Business, 25 Int'l Law 223 (1991). Congress prevented such taxation in U.S. territories, on which it may impose all "needful Rules and Regulations," U.S. Const. art. IV, § 3, cl.2, by establishing a temporary tax holiday for FSCs incorporated there. Under IRC § 927(e)(5)(A), Congress provided "no tax shall be imposed by any possession of the United States on any foreign trade income derived before January 1, 1987." To encourage territories to extend favorable tax treatment to FSCs, Congress also provided: "nothing in any provision of law shall be construed as prohibiting any possession of the United States from exempting from tax" any foreign trade income, interest income, and carrying charges*fn7 of a FSC. IRC § 927(e)(5)(B).

Because FSCs may generate significant revenue, many U.S. possessions and foreign jurisdictions attempted to lure them by creating special tax incentives. See Bernet, supra ; see also Walter H. Diamond, Foreign Sales Corporations: Final IRS Regulations and Host Government Incentives xii (1987). The Virgin Islands has been particularly effective in attracting FSCs, see Bernet, supra (82% of FSCs world-wide are incorporated in the U.S. Virgin Islands); Edward E. Thomas, Revenue Letter to Commissioner Wetzler, 91 Tax Notes Int'l 45 (Nov. 6, 1991) (4,000 FSCs, representing 80% of FSCs world-wide, are incorporated in the U.S. Virgin Islands), and its success has been due, in part, to its scheme of FSC taxation. See Carey R. D'Avino, General Explanation of the U.S. Virgin Islands FSC Legislation, 85 Tax Notes Today 1-63 (Jan. 2, 1985) (influx of FSCs to the Virgin Islands resulted from favorable tax treatment).

C.

As Virgin Islands corporations, FSCs would be obligated, in the absence of any special exemptions, to pay income taxes to the Virgin Islands government under the "mirror code" provision, 13 U.S.C. § 1397 (1988), which makes the IRC applicable to all Virgin Islands residents. See Danbury, Inc. v. Olive, 820 F.2d 618, 620 (3d Cir.) ("to satisfy Virgin Islands tax obligations, an individual or corporation in the Virgin Islands pays taxes to the [Virgin Islands Bureau of Revenue] equivalent to taxes an individual or corporation under the same circumstances in the United States would pay to the Internal Revenue Service."), cert. denied, 484 U.S. 964, 98 L. Ed. 2d 393, 108 S. Ct. 453 (1987). This provision has been incorporated into, and is the basis of, Virgin Islands income tax law.*fn8 33 V.I.C. § 1931(15); see Abramson Enters., Inc. v. Government of Virgin Islands, 994 F.2d 140, 141-42 (3d Cir. 1993); HMW Indust., Inc. v. Wheatley, 504 F.2d 146, 150 (3d Cir. 1974). Although, generally, the Virgin Islands may not reduce or remit tax liability "in any way, directly or indirectly," see IRC § 934(a), Congress has, as noted above, invited the Virgin Islands to exempt FSC income from taxation. See IRC § 927(e)(5)(B).

Under the aegis of § 927(e)(5)(B), the Virgin Islands legislature has created a special Chapter of its Corporations and Associations Law, containing tax exemptions for FSCs. See 13 V.I.C. §§ 773-78 (Supp. 1990). By its express terms, "the benefits granted under this chapter . . . apply only to [a] FSC incorporated in the Virgin Islands." 13 V.I.C. § 771(1).

Under these provisions, Virgin Islands FSCs, and their shareholders, are exempt from several generally applicable income and property taxes. For example, no taxes are payable on foreign trade income,*fn9 investment income, and carrying charges*fn10 until January 1, 1997. 13 V.I.C. § 773. Although other companies must pay a gross receipts tax on apportioned gross receipts from the sale or Disposition of property (33 V.I.C. §§ 41, 42), FSCs are exempt. 13 V.I.C. § 774. Moreover, although U.S. citizens receiving distributions from Virgin Islands companies are ordinarily taxed on those distributions (26 U.S.C. §§ 871(a)(1), 881), the Virgin Islands FSC provisions exempt U.S. residents, citizens, and companies from taxes on shareholder distributions. 13 V.I.C. § 777.*fn11

The Virgin Islands Code also contains exemptions for FSC-held property. Import property is exempt from customs duties if the FSC intends to reexport it. 13 V.I.C. § 776. FSCs are exempt from payment of excise taxes (33 V.I.C. § 42) on all export property, 13 V.I.C § 775, and customs duties, which are ordinarily payable under 33 V.I.C. § 525. 13 V.I.C. § 776.

In order to assure FSCs that after their incorporation in the Virgin Islands these exemptions would remain inviolate, the legislature directed the Office of the Lieutenant Governor to enter a contract with every FSC upon request. 13 V.I.C. § 780. The contract must specify "that the benefits of this chapter as they exist on [their] effective date . . . shall be and remain available to said FSC, and shall not be reduced, until at least January 1, 1997 . . . ." Id. The contract must also provide "that the Government shall not adopt any legislation impairing or limiting the obligation of such contract." Id. As a further assurance to FSCs, § 780 requires the Lieutenant Governor to enter the contract "within thirty (30) days of a request by the FSC to do so . . . ." Id.

The Virgin Islands legislature did not, however, exempt FSCs from all taxes and fees. FSCs must pay a fee for filing articles of incorporation, as well as annual licensing fees and franchise taxes. These assessments are at the heart of this appeal.

D.

Under 13 V.I.C. § 431(a)(1), FSCs pay a $400 fee for filing articles of incorporation.*fn12 If a company incorporates and later elects FSC status, it pays a $500 penalty. Id.*fn13 Moreover, an annual license fee is "levied upon all persons and associations engaged in [] designated businesses" under 27 V.I.C. § 302.*fn14 FSCs pay $100 annually.

As all Virgin Islands corporations, FSCs pay an annual franchise tax. Non-FSC corporations pay on the amount of "capital stock used in conducting business in the Virgin Islands." 13 V.I.C. § 531(a). The tax is assessed at $1.50 for each thousand dollars of stock, with a $100 minimum. FSC franchise taxes, however, are calculated with reference to the amount of their "non-Virgin Islands trading gross receipts."

As defined by statute, "Non-Virgin Islands trading gross receipts" means

the gross receipts of any FSC which are:

(1) from the sale, exchange, or other Disposition of non-Virgin Islands export property for direct use, consumption, or Disposition outside the Virgin Islands;

(2) from the lease or rental of non-Virgin Islands export property for use by the lessee outside the Virgin Islands;

(3) for services which are related and subsidiary to:

(A) any sale, exchange, or other Disposition of non-Virgin Islands export property by any such corporation;

(B) any lease or rental of non-Virgin Islands export property for use by the lessee outside the Virgin Islands;

(4) for engineering or architectural services for construction projects located (or proposed to be located) outside the Virgin Islands; or

(5) for the performance of managerial services for an unrelated FSC in furtherance of the production of non-Virgin Islands trading gross receipts as described in items (1), (2), or (3) of this definition; provided that item (5) shall not apply to a FSC for any taxable year unless at least fifty percent (50%) of its gross receipts for such taxable year are derived from activities described in items (1), (2), or (3) of this definition.

13 V.I.C. § 770; see also 13 V.I. Regs. § 770-1(i).

Thus, in calculating its franchise tax liability for a given year, a FSC must determine its non-Virgin Islands trading gross receipts under § 770 for the taxable year and look to the tax table in §§ 531b(b) and 531c(b). Under § 531b(b), "small FSCs"*fn15 pay a $400 franchise tax if it has $2 million or less in non-Virgin Islands trading gross receipts and $900 if it has between $2 and $5 million. 13 V.I.C. § 531b(b). Other FSCs pay franchise taxes as follows:

Non-Virgin Islands

Gross Receipts

greater than But not more than Minimum tax

$0 $10,000,000 $1,000

10,000,000 20,000,000 2,500

20,000,000 50,000,000 5,000

50,000,000 100,000,000 10,000

100,000,000 250,000,000 15,000

250,000,000 500,000,000 20,000

500,000,000 - ...


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