50 T.C. 710">*710 The Commissioner determined deficiencies in the income tax of petitioners Erich and Garbriele Grunebaum and 1968 U.S. Tax Ct. LEXIS 87">*88 petitioners Kurt and Anneliese Grunebaum for the year 1961 in the amounts of $ 37,490.69 and $ 39,435.07, respectively. As a result of concessions made by the petitioners approximately three-fourths of these deficiencies are no longer being contested. The remaining matter in the dispute relates to the application of the overall limitation on the credit for foreign taxes under section 904(a)(2), I.R.C. 1954. The numerator of the limiting fraction in those provisions is "taxable income from sources without the United States," and that term is defined in section 862(b). The precise issue is whether certain deductions for charitable contributions, interest, taxes, storm damage, and accounting fees are "deductions which cannot definitely be allocated to some item or class of gross income" within the meaning of section 862(b), so that a "ratable part" of such deductions must be subtracted from foreign gross income in order to arrive at "taxable income from sources without the United States."

FINDINGS OF FACT

The stipulation of facts submitted by the parties, along with accompanying exhibits, is incorporated herein by this reference.

50 T.C. 710">*711 Erich O. and Gabriele H. Grunebaum, petitioners in docket 1968 U.S. Tax Ct. LEXIS 87">*89 No. 4170-66 (hereinafter sometimes referred to as Erich and Gabriele), are husband and wife who were legal residents of Scarsdale, N.Y., at the time their petition was filed in this case. Kurt H. and Anneliese Grunebaum, petitioners in docket No. 4171-66 (hereinafter sometimes referred to as Kurt and Anneliese) are husband and wife who were legal residents of Harrison, N.Y., at the time their petition was filed. Each couple filed its joint Federal income tax returns for the year 1961 with the district director of internal revenue, Manhattan, N.Y.

Erich and Kurt Grunebaum are brothers who, until 1938, were partners in a family banking business in Essen, Germany. In that year, the Nazi government expropriated their family's entire interest in this banking concern. Most of the bank's business was thereafter taken over by a newly formed firm in which Erich and Kurt and members of their family had no interest.

Erich and Kurt were "forced" to leave Germany in 1938, and they immigrated to the United States, through Canada, in 1941. In 1942, they became employed by the New York Hanseatic Corp. (Hanseatic), a corporation engaged in the investment banking business in New York City. F. H. 1968 U.S. Tax Ct. LEXIS 87">*90 Hirschland, a relative, was a director of Hanseatic, and is still a director and a stockholder today. The "family" increased its stock interest in Hanseatic at this time, and Erich and Kurt have continued to purchase Hanseatic stock whenever funds were available. Today, they and their relatives hold approximately 55 to 60 percent of Hanseatic's stock, the remainder being held by approximately 60 unrelated stockholders.

At the present time, Hanseatic is one of the largest "over the counter" trading organizations in the United States. It is one of 21 Government bond dealers recognized by the Federal Reserve Board, and is an associate member of the American Stock Exchange. Its business is primarily domestic, largely underwriting of corporate stock and dealing in Government bond issues, but it has occasionally participated in European bond offerings. During 1961, Erich served as chairman of the board of Hanseatic, its senior officer, and Kurt served as its president.

In 1950, the German Government offered restitution to Erich, Kurt, and other relatives for the 1938 expropriation of their banking business in Essen, Germany. A settlement was reached under which the successors to their 1968 U.S. Tax Ct. LEXIS 87">*91 former firm continued to run the bank as general partners, and they took a minority position in the bank as limited partners. At the request of the German general partners, all these limited partnership interests were and are held in the name of a single nominee, Simon Hirschland, Inc., a New York corporation created solely for this purpose, and are registered under that name in the 50 T.C. 710">*712 German Commercial Register. However, partnership distributions are made directly to Kurt, in the form of a check drawn to his order, and he distributes them to the other limited partners. No distributions have ever actually been made to Simon Hirschland, Inc. German taxes are withheld at the source on all partnership distributions of income, and German tax returns are filed for the partners by accountants in Germany.

No U.S. corporate income tax returns have ever been filed for Simon Hirschland, Inc. However, partnership returns are filed in the name of the "Hirschland-Grunebaum joint venture," detailing the amounts of partnership distributions received from the German bank, the share of each limited partner, and the German taxes paid on such amounts. Erich and Kurt each have a one-third interest in 1968 U.S. Tax Ct. LEXIS 87">*92 this joint venture, and two cousins each have a one-sixth interest, which corresponds with their stock ownership in Simon Hirschland, Inc. Each "joint venturer" reports his share of the distributions reported on these partnership returns on his individual return. Erich, Kurt, and their two cousins filed partnership information returns in the name of the Hirschland-Grunebaum joint venture, rather than corporate returns for Simon Hirschland, Inc., to clarify for the American taxing authorities that income received from the German bank was properly taxable to them and not to Simon Hirschland, Inc., since they were the real owners of the limited-partnership interests in the German bank, and Simon Hirschland, Inc., was merely the nominal or record owner of such interests.

Both Erich and Kurt devoted their full time to Hanseatic in 1961. Neither rendered any services in 1961 to the German banking firm in which they held only a limited partnership interest.

On their joint tax return for the year 1961, Erich and his wife Gabriele reported gross income of $ 265,670.58 from the following sources:

1968 U.S. Tax Ct. LEXIS 87">*93 50 T.C. 710">*713 Erich and Gabriele claimed total deductions from gross income, apart from personal exemptions and after certain adjustments made by the Commissioner which they do not dispute here, of $ 85,135.35. Their taxable income for 1961 before deduction for personal exemptions, as adjusted, was $ 180,535.23.

On the joint return filed by Kurt and Anneliese for 1961, they reported gross income of $ 261,355.55 from the following sources:

Kurt and Anneliese claimed total deductions from gross income, apart from personal exemptions and after certain adjustments made by the Commissioner which are not disputed here, of $ 91,192.98. Their taxable income for 1961 before deduction for personal exemptions, as adjusted, was $ 170,162.57.

The joint return filed by Erich and Gabriele disclosed that they had paid foreign taxes in 1961 in 1968 U.S. Tax Ct. LEXIS 87">*94 the sum of $ 90,833.46; the return filed by Kurt and Anneliese similarly disclosed the payment of foreign taxes in the sum of $ 90,646.40. Both Erich and Gabriele and Kurt and Anneliese elected the provisions of section 901 of the Internal Revenue Code of 1954, which allows a taxpayer to take foreign taxes paid or accrued during the taxable year as a direct credit against his income tax, computed without deduction for such foreign taxes, subject to the applicable limitation elected by the taxpayer under section 904. Both elected to apply the overall limitation on the foreign tax credit as set forth in section 904(a)(2), which, in general provides that the amount of the credit may not exceed the same proportion of the tax against which the credit is taken which the taxpayer's taxable income from sources without the United States bears to his total taxable income. In determining this limitation, taxable income is to be computed without any deduction for personal exemptions. Sec. 904(c).

50 T.C. 710">*714 On Form 1116 attached to their joint return, Erich and Gabriele determined the overall limitation on their foreign tax credit to be $ 91,499.08, computed as follows:

$ 169,044.02 (taxable income from 1968 U.S. Tax Ct. LEXIS 87">*95 sources without the United States)/$ 178,472.73 (taxable income from all sources) X $ 96,599.54 (total U.S. income tax before foreign tax credit) = $ 91,499.08 (overall limitation)

Since the overall limitation thus computed was greater than the $ 90,833.46 in foreign taxes paid or accrued by them in 1961, they took the entire amount of such foreign taxes as a credit against their income tax for that year.

In his notice of deficiency to petitioners Erich and Gabriele Grunebaum, the Commissioner recomputed this limitation as follows:

$ 98,104.60 (taxable income from sources outside the U.S.)/$ 180,535.23 (taxable income from all sources, as adjusted) X $ 98,163.07 (total U.S. tax before foreign tax credit, as adjusted) = $ 53,342.77 (overall limitation)

Thus, the Commmissoner determined that Erich and Gabriele were entitled to a foreign tax credit of no more than $ 53,342.77, the amount of the overall limitation as recomputed.

Kurt and Anneliese determined the overall limitation on their foreign tax credit to be $ 88,683.68, computed as follows:

$ 167,639.34 (taxable income from sources without the U.S.)/$ 168,162.57 (taxable income from all sources) X $ 88,959.45 (total U.S. income tax before 1968 U.S. Tax Ct. LEXIS 87">*96 foreign tax credit) = $ 88,683.68 (overall limitation)

Since the overall limitation thus computed was smaller than the $ 90,646.40 in foreign taxes paid or accrued by them in 1961, they claimed a foreign tax credit in the lesser amount of $ 88,683.68.

In his notice of deficiency to petitioners Kurt and Anneliese Grunebaum, the Commissioner recomputed the limitation as follows:

$ 93,458.34 (taxable income from sources without the U.S.)/$ 170,162.57 (taxable income from all sources, as adjusted) X $ 90,459.45 (total U.S. income tax before foreign tax credit, as adjusted) = $ 49,683.02 (overall limitation)

The Commissioner thus determined that Kurt and Anneliese were entitled to a foreign tax credit of no more than $ 49,683.02, the amount of the overall limitation as recomputed.

The petitions filed by Erich and Gabriele Grunebaum and by Kurt and Anneliese Grunebaum both assigned as error the Commissioner's determination of taxable income from sources without the United States for purposes of computing the overall limitation on the foreign 50 T.C. 710">*715 tax credit. Petitioners claimed on their returns and in their petitions that their taxable income from sources without the United States equaled their foreign 1968 U.S. Tax Ct. LEXIS 87">*97 gross income. ^{11968 U.S. Tax Ct. LEXIS 87">*98} The Commissioner, however, determined that such foreign gross income should have been reduced as follows in determining "taxable income" from sources without the United States:

50 T.C. 710">*716 1968 U.S. Tax Ct. LEXIS 87">*99 Petitioners now agree with the Commissioner's determination in respect of that portion of the capital gains deduction which he treated as definitely attributable to their foreign gross income. They now dispute only his determination that certain deductions claimed on their returns were not definitely attributable to either foreign or domestic income and required allocation between these two categories. These disputed deductions, which petitioners allege were the sole product of domestic activities and were proximately related to domestic income, are as follows:

1968 U.S. Tax Ct. LEXIS 87">*100 50 T.C. 710">*717 Petitioners do not contest the precise allocations made by the Commissioner if it should be held that any allocation was proper.

The insurance loans on which Erich and Gabriele paid and deducted interest represent borrowings from two insurance companies to pay premiums on insurance policies. The bank loans of Erich and Gabriele represent funds borrowed for the construction of a summer residence in Cape Cod, Mass., and also to purchase additional shares of Hanseatic. Kurt and Anneliese obtained their bank loans to finance Kurt's private art collection, as well as to purchase additional shares of Hanseatic. Both Erich and Gabriele and Kurt and Anneliese paid the foregoing accounting fees for the preparation of their State and Federal income tax returns.

OPINION

Section 901 of the Internal Revenue Code of 1954 entitles a taxpayer, if he so elects, to credit directly against his income tax certain taxes paid to foreign countries or possessions of the United States, "subject to the applicable limitation of section 904." Section 904(a) contains two alternative limitations on this foreign tax credit, the per country limitation and the overall limitation, the choice between them being left, 1968 U.S. Tax Ct. LEXIS 87">*101 at least initially, with the taxpayer. Both are designed to prevent the amount of foreign taxes credited from offsetting U.S. tax on the taxpayer's domestic income, i.e., to restrict the amount of foreign taxes credited to roughly what the U.S. income tax would otherwise have been on the taxpayer's foreign source income. H. Rept. No. 1358, 86th Cong., 2d Sess., p. 2 (1960), S. Rept. No. 1393, 86th Cong., 2d Sess., p. 3 (1960); H. Rept. No. 350, 67th Cong., 1st Sess., p. 13 (1921).

Petitioners Erich and Kurt Grunebaum, who together with their respective wives filed joint Federal income tax returns for 1961, paid or incurred foreign taxes in 1961 in the amounts of $ 90,833.46 and $ 90,646.40, respectively, and each credited foreign taxes directly against 50 T.C. 710">*718 U.S. income tax. Each elected to apply the overall limitation in computing the allowable amount of the foreign tax credit, which provides that "the total amount of the credit * * * shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources without the United States * * * bears to his entire taxable income for the same taxable year." Sec. 904(a)(2), I.R.C. 1954. 1968 U.S. Tax Ct. LEXIS 87">*102 ⁴ Stated another way, the maximum amount allowable as a foreign tax credit under the overall limitation is expressed by the formula:

Taxable income from sources without the United States/Total taxable income X U.S. tax before credit for foreign taxes

Erich Grunebaum computed his overall limitation to be $ 91,499.08, which amount was greater than the sum of foreign taxes paid or accrued during 1961; he therefore claimed the full amount of $ 90,833.46 as a foreign tax credit. Kurt Grunebaum computed his overall limitation to be $ 88,683.68, which was less than the sum of foreign taxes paid or accrued 1968 U.S. Tax Ct. LEXIS 87">*103 by him during 1961, and under the statute he could and did claim only the lesser amount as his foreign tax credit. However, the Commissioner recomputed the overall limitation in each case, and determined that under such limitation, properly computed, the maximum amount allowable as a foreign tax credit to Erich was $ 53,342.77, and that Kurt's maximum allowable credit was $ 49,683.02. In his recomputations, the Commissioner adjusted the total taxable income of both Erich and Kurt, and the amount of income tax due after such adjustments, to reflect his disallowance of certain unallowable or unsubstantiated deductions. Those adjustments affected both the denominator of the limiting fraction and the U.S. tax computed without the foreign tax credit, but those adjustments are not contested by petitioners, and that much of the overall limitation formula does not, therefore, concern us here. In addition, the Commissioner in each case reduced the taxable income from sources without the United States by subtracting from the foreign gross income reported a ratable portion of certain deductions claimed in the respective returns. Since the foreign "taxable income" is the numerator of the limiting 1968 U.S. Tax Ct. LEXIS 87">*104 fraction, the Commissioner's allocation of a portion of these deductions to such foreign "taxable income" had the effect of lowering the overall limitation 50 T.C. 710">*719 and thus the maximum allowable foreign tax credits, and it is this action which petitioners dispute.

The issues raised in each case are, except for the amounts involved, identical. Both Erich and Kurt received all but a minor portion of their foreign income in 1961 from distributions in respect of limited-partnership interests held by them in a German banking concern. ⁵ These distributions appear to have been received by them without expense, other than that of German taxes which were withheld at the source, and without the rendition of any services on their part in 1961. They therefore concluded that, for the purpose of computing the overall limitation on the foreign tax credit, the "taxable income from sources without the United States" of each of them was equal to their respective foreign gross incomes, without any deductions. The Commissioner, however, determined that a large portion of the capital gains deductions claimed by each of them in computing the tax on their long-term capital gains related directly to distributions 1968 U.S. Tax Ct. LEXIS 87">*105 from the German banking concern which they treated on their returns as long-term capital gains, and he accordingly allocated and subtracted that portion from their foreign gross incomes. His determination in this respect accounted for the major portion of the deficiencies, and petitioners now accept it as correct. But they argue that the Commissioner erred in his further determination that deductions claimed by both Erich and Kurt for charitable contributions, interest, State and local taxes, accounting fees, and casualty losses due to storm damage were not definitely attributable to either domestic or foreign income and were therefore allocable ratably between domestic and foreign gross income; they contend that all these deductions related solely to domestic gross income and were allocable wholly thereto, so that no part of those deductions could be used to reduce their "taxable income from sources without the United States."

The Commissioner's action with respect to the deductions in dispute was predicated on the command of section 862(b) of the Internal Revenue Code of 1954, which 1968 U.S. Tax Ct. LEXIS 87">*106 requires that, in determining "taxable income from sources without the United States," there shall be deducted from foreign gross income "the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income" (emphasis supplied). It is clear that, in determining "taxable income from sources without the United States" under these provisions, a taxpayer must thus subtract from his foreign gross income not only those deductions properly allocable to 50 T.C. 710">*720 such foreign income but also a ratable share of all other deductions claimed in computing his total taxable income for purposes of determining the income tax imposed by section 1 of the 1954 Code which cannot be shown to be definitely related to his domestic income. ⁶ If such relationship cannot be established, the allocation must be made notwithstanding the fact that the taxpayer may have paid taxes on his foreign income which did not take such allocated deductions into account. See International Standard Electric Corporation, 1 T.C. 1153">1 T.C. 1153, 1 T.C. 1153">1157-1159, affirmed and modified on another 1968 U.S. Tax Ct. LEXIS 87">*107 issue 144 F.2d 487, 489 (C.A. 2), certiorari denied 323 U.S. 803">323 U.S. 803; followed in South Porto Rico Sugar Co., 2 T.C. 738">2 T.C. 738, 2 T.C. 738">743. Cf. Missouri Pacific Railroad Co. v. United States, 392 F.2d 592 (Ct. Cl.). Moreover, in light of the Commissioner's determination here, the burden is upon petitioners to demonstrate that the deductions allocated between domestic and foreign gross income were in fact "definitely" related to the earning of income within the United States in the degree contemplated by the statute. Cf. De Nederlandsche Bank, 35 B.T.A. 53">35 B.T.A. 53, 35 B.T.A. 53">59-60.

Petitioners' proof in this regard, apart from the stipulated facts, consisted solely of the testimony of Erich and Kurt Grunebaum, which was fragmentary and summary in character. We hold that no error has been shown in the Commissioner's determination in respect of any of these deductions.

1. Charitable Contributions. -- As to the deduction 1968 U.S. Tax Ct. LEXIS 87">*108 for charitable contributions, the Commissioner's action was plainly correct. Such contributions (in the aggregate amount of $ 3,541.68 for Erich and Gabriele and $ 2,875 for Kurt and Anneliese) were clearly not a charge against or "definitely" allocable to petitioners' domestic income. To the contrary, they were personal in character and had no proximate connection with the production of any income; they were unrelated to any particular item or class of income, domestic or foreign, and appear to have been made out of the aggregate of petitioners' funds, whatever their source. It is entirely immaterial under the Code that petitioners resided in the United States, that their domestic income was attributable in large part to services here, and that their income from foreign sources was "passive." The statute requires that where the deduction "cannot definitely be allocated to some item or class of gross income," a "ratable part" thereof must be deducted from foreign gross income. Indeed, unless a charitable contribution is deductible as a business expense under section 162 and referable to a particular item or class of gross income, it is just like a number of other deductions 50 T.C. 710">*721 of 1968 U.S. Tax Ct. LEXIS 87">*109 a personal character which are allowable as a matter of legislative grace and must be regarded as a charge against the taxpayer's entire income rather than against any particular portion thereof. Certainly, petitioners have not established that the Commissioner erred in respect of the deductions for charitable contributions.

2. Interest. -- Nor has any error been shown in regard to the deductions for interest. These deductions consist of four components in the case of Erich and Gabriele. The first component is $ 417.50 interest on "insurance loans." These loans were made to pay part of the premiums on insurance policies, and there is no showing that the policies were anything other than personal in character. The second component is $ 1,005.04 interest on "Bank Loans." The evidence shows that there were two such bank loans in undisclosed amounts, one to finance the building of a summer house in Cape Cod for these petitioners, and the other in connection with the purchase of some additional New York Hanseatic Corp. stock. The interest on the former loan was plainly personal in character, and not shown to be directly related to any domestic income. ^{71968 U.S. Tax Ct. LEXIS 87">*111} The interest on the second loan 1968 U.S. Tax Ct. LEXIS 87">*110 may have been related to domestic income, namely, dividends from Hanseatic. But neither the amount of that loan nor that amount of interest in respect thereof was revealed in the evidence before us. For aught that appears, such interest may have been minimal in amount, and we cannot say on this record that the Commissioner's allocation of the total $ 1,005.04 interest on the two bank loans between domestic and foreign income was in error. The third and fourth components were $ 119.03 interest on "Taxes" (not otherwise identified) and $ 881.92 interest on "Real Estate Mortgages" (not otherwise identified). Here, too, petitioners have failed to carry their burden of proof to establish that either of these components can "definitely be allocated" to domestic income or some item or class of domestic income.

The interest deductions in the case of Kurt and Anneliese consist of three components. The first two are interest on "Taxes" (not otherwise identified) in the amount of $ 271.19 and interest on "Real Estate Mortgages" (not otherwise identified) in the amount of $ 1,121.77. What we have said in respect of the similarly designated components in the case of Erich and Gabriele is equally applicable here. The third component is "Bank Loans" in the amount of $ 3,397.81. The evidence shows that these loans were obtained partly to finance Kurt's "rather extensive art collection," and partly to buy additional Hanseatic 50 T.C. 710">*722 stock. The interest on the loan to finance Kurt's art collection was plainly personal and not related in any way to his domestic income. And as in Erich's case, the amount of interest in respect of the loan to purchase stock was not shown. On this record, our decision must be the same as the one reached in respect of Erich's bank loans.

3. Taxes. -- The third major category of deductions involved in both cases is "Taxes" in the aggregate amount of $ 14,039.53 for Erich and Gabriele 1968 U.S. Tax Ct. LEXIS 87">*112 and in the aggregate amount of $ 16,770.34 for Kurt and Anneliese. In each case this item consists of five components: (a) Real estate taxes, (b) State and local sales taxes, (c) State income taxes, (d) automobile taxes, and (e) gasoline taxes. We cannot find on this record that any one of these components in either case can "definitely be allocated" to domestic income and that it was error on the part of the Commissioner to allocate them ratably to both domestic and foreign income. There is some evidence that Erich and Kurt each used his home for business entertaining, but the amount of allowable deduction, if any, in respect thereof was not shown, and, to the extent that a deduction for business entertaining generally in each case was allowed, the Commissioner allocated it entirely to domestic income. Accordingly, we cannot say that any of the real estate taxes here in issue were anything other than personal or were "definitely" chargeable to domestic income only. As to State income taxes, if it be assumed that a portion thereof might be chargeable directly to domestic income, then by parity of reasoning the remaining portion would be chargeable directly to foreign income, and 1968 U.S. Tax Ct. LEXIS 87">*113 there is no evidence before us showing that the Commissioner's allocation of the entire item to both foreign and domestic income produced a result that was any less favorable to petitioners. As to the remaining taxes, there is not even a suggestion to indicate that they were anything other than personal.

4. Storm Damage. -- A deduction for storm damage was claimed in both cases, $ 176.80 for Erich and Gabriele and $ 830 for Kurt and Anneliese. This item was plainly personal in character, and the Commissioner was fully justified in allocating it ratably between foreign and domestic gross income.

5. Accounting Fees. -- Finally, there is in dispute the Commissioner's allocation of the deduction for accounting fees, $ 250 in the case of Erich and Gabriele and $ 375 in the case of Kurt and Anneliese. The evidence discloses that these fees were paid for preparation of income tax returns, and what we have said above in connection with allocation of petitioners' income taxes themselves is equally applicable here. We sustain the action of the Commissioner.

Decisions will be entered under Rule 50.