On Appeal from the District Court of the Virgin Islands. (Civil No. 89-00112). (Civil No. 91-00289). (D.C. Nos. 89-00112 and 89-00289).
Before: Greenberg, Scirica and Garth, Circuit Judges.
This appeal concerns the narrow question of whether the corporate surtax imposed on Virgin Islands taxpayers pursuant to V.I.Code Ann. tit. 33, § 581 (Supp. 1990) ("§ 581") is deductible from Virgin Islands taxable income under § 164 of the Internal Revenue Code ("§ 164") as applied to the Virgin Islands under the "mirror system" of taxation. We conclude that the surtax is non-deductible and, accordingly, we will reverse the judgment of the district court and direct that judgment be entered in favor of the Virgin Islands Bureau of Internal Revenue.
The relevant facts are not in dispute. The instant appeal encompasses two related actions, consolidated below, which arose when appellants, Virgin Islands Bureau of Internal Revenue and its Directors of record for the relevant periods (collectively, "VIBIR"), assessed tax deficiencies against appellee, Abramson Enterprises, Inc. ("Abramson"), for the years 1986, 1987 and 1988. Abramson had paid the 10% corporate surtax on income imposed by the Virgin Islands and had then deducted the amount of the surtax from its Virgin Islands taxable income.
As the Disposition of the case unfolded, the district court first heard the case involving Abramson's 1986 return and issued a memorandum opinion holding that the surtax was not deductible. However, on consideration of the alleged deficiencies for tax years 1987 and 1988, the district court reconsidered the 1986 case as well. After a bench trial, the district court retracted its earlier Conclusion and, in a Memorandum and Order dated March 23, 1992, held that the corporate surtax imposed by the Virgin Islands is deductible from the taxable income of Virgin Islands corporations. The district court therefore concluded that the notices of deficiency, to the extent that they were related to Abramson's deductions of corporate surtax for the tax years 1986-88, were invalid. VIBIR appeals that decision.
All facts giving rise to this appeal were stipulated by the parties, and because our holding turns only on a matter of law, our review of the district court's order of March 23, 1992 is plenary. We preface our review with a brief Discussion of the relevant statutory framework. The Internal Revenue Code of the United States is made applicable to the Virgin Islands pursuant to the Naval Service Appropriation Act of 1922, 48 U.S.C.A. § 1397 (1987):
The income-tax laws in force in the United States of America and those which may hereinafter be enacted shall be held to be likewise in force in the Virgin Islands of the United States, except that the proceeds of such taxes shall be paid into the treasuries of said islands . . . .
The result of this statute has been to create a "mirror system" of taxation under which Virgin Islands residents discharge their United States tax liability by paying all income taxes directly to the Treasury of the Virgin Islands. The "mirror system" has been applied through rules of construction promulgated by the Internal Revenue Service, VIBIR and the courts. These rules were summarized by this court in Johnson v. Quinn, 821 F.2d 212 (3d Cir. 1987):
The Internal Revenue Service has stated that in construing the IRC as in force in the Virgin Islands it is "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 Sayre & Co. v. Riddell, 395 F.2d 407 (9th Cir. 1968), a case cited with approval by this circuit . . . the court, construing Guam's comparable mirror code, noted Congress's codification of the word substitution rule in 42 U.S.C. § 1421(e), which states that "except where it is manifestly otherwise required, the applicable provisions of the Internal Revenue Code . . . shall be read so as to substitute 'Guam' for 'United States.'" 395 F.2d at 412-13.
As the law has developed under the mirror system, the provisions of the Internal Revenue Code are applicable to the Virgin Islands so long as the specific section to be applied is not "manifestly inapplicable or incompatible with a separate territorial income tax." Chicago Bridge and Iron Co. v. Wheatley, 430 F.2d 973, 976 (3d Cir. 1970) (citations omitted). Moreover, under the "equality principle" discussed in Johnson v. Quinn, 821 F.2d 212 (3d Cir. 1987), "'the tax to be paid [to the Virgin Islands] ordinarily is measured by the amount of income tax the taxpayer would be required to pay to the United States of America if the taxpayer were residing in the continental United States.'" Id. at 214 (quoting Chicago Bridge, 430 F.2d at 975-76).