71 T.C. 357">*357 OPINION

Respondent determined deficiencies in petitioner's Federal income taxes in the amounts of $ 354,228.07 and $ 2,030,062.96 for the taxable years ended October 31, 1972, and October 31, 1973, respectively. Petitioner has conceded the correctness of some of the adjustments respondent made in the notice of deficiency, leaving for our decision only the proper amount of commission income of petitioner's domestic international sales corporation (DISC) subsidiary, Longview Fibre Co. 1978 U.S. Tax Ct. LEXIS 13">*14 International, on sales of logs for petitioner.

A DISC is not taxable on its profits, but under section 995, I.R.C. 1954, ¹ the parent of the DISC subsidiary is in its current year taxable on one-half of the income of the DISC subsidiary and the tax on the other one-half is deferred. When the income of the DISC subsidiary consists of commissions on qualified sales for the parent, the parent in computing its taxable income is entitled to deduct in the year of the sale the entire commission income of the DISC. Section 994(a)^{21978 U.S. Tax Ct. LEXIS 13">*16} provides for the intercompany 71 T.C. 357">*358 pricing rules to be used in computing the income of the DISC. ^{31978 U.S. Tax Ct. LEXIS 13">*17 1978 U.S. Tax Ct. LEXIS 13">*18} The parties do not differ with respect to the right of petitioner to deduct, in computing its taxable income for each year here in issue, the commission income of its DISC or that this commission income is to be computed under section 994(a). ⁴ The difference between the parties is solely as to what constitutes the "combined taxable income" of petitioner and its DISC from 71 T.C. 357">*359 qualified export sales. The precise issue is the cost to be used for the logs sold in determining this income. This issue arises because petitioner owns the land on which it grows timber and from 1978 U.S. Tax Ct. LEXIS 13">*15 which it cuts the logs exported and sold by its DISC for it on a commission basis, and petitioner has elected to consider the cutting of its timber as a sale or exchange of timber under section 631.

All of the facts have been stipulated and are found accordingly.

Petitioner is a corporation with its principal office in Longview, Wash. It keeps its books and files its tax returns on the basis of a fiscal 1978 U.S. Tax Ct. LEXIS 13">*19 year ended October 31. For each of its fiscal years 1972 and 1973, petitioner filed its Federal corporate income tax return with the Internal Revenue Service Center in Ogden, Utah.

Petitioner's principal business is the manufacture of paper and related products derived from wood fiber. For use in its manufacture, petitioner grows timber, principally Douglas fir and western hemlock trees. Typically, this timber requires approximately 40 to 80 years to mature to the size for optimum marketing. Petitioner manages its timber crop on a sustained yield basis, coordinating harvest with growth so that timber can be indefinitely harvested from petitioner's lands. During the last two decades, petitioner's timber harvest has had a market value in excess of the amount that could be realized by petitioner from processing the timber in its own manufacturing operations. Consequently, petitioner has followed the practice of marketing its timber harvest at its highest market value and acquiring the wood fiber needed for its manufacturing operations from other sources. The timber cut in each of petitioner's fiscal years 1972 and 1973 was sold in the same year when it was cut.

During its fiscal 1978 U.S. Tax Ct. LEXIS 13">*20 years 1972 and 1973, petitioner had in effect the election provided by section 631(a). Accordingly, petitioner treated the cutting of its timber in those years as a sale of such timber and determined its gain on the basis of the difference in the fair market value of its timber at the beginning of each fiscal year and its adjusted basis in the timber. Sec. 631(a). It reported the gain so computed as capital gain under sections 1231, 1222(3), 1222(11), and 1201(a). In computing its ordinary income from the sale of logs on its tax return for each of its fiscal years 1972 and 1973, petitioner used as its costs of goods 71 T.C. 357">*360 sold log costs computed by using the fair market value of the timber at the beginning of each year.

During its fiscal years 1972 and 1973, petitioner exported products produced in the United States to foreign countries. In the exporting operations, petitioner's domestic international sales corporation (DISC) subsidiary, known as Longview Fibre Co. International, acted as commission agent for petitioner's export sale of logs. At all times pertinent to the issue in this case, Longview Fibre Co. International has been a domestic international sales corporation, or DISC, 1978 U.S. Tax Ct. LEXIS 13">*21 as defined by section 992(a). Under a written agreement between petitioner and its DISC subsidiary, the DISC was entitled to commissions "equal to the maximum amount permitted to be received by a DISC company under the inter-company pricing rules of section 994 of the Internal Revenue Code of 1954."

During its taxable years ended October 31, 1972, and October 31, 1973, petitioner's DISC subsidiary earned a commission on petitioner's export of logs equal to the maximum amount allowable under the inter-company pricing rules of section 994. Using the 50-percent of combined taxable income method as provided in section 994(a)(2), petitioner computed its DISC's commissions as follows:

Respondent computed the amount of the DISC's commission 1978 U.S. Tax Ct. LEXIS 13">*22 by subtracting from the qualified export receipts the fair market value of the standing timber on the first day of the taxable year. The effect of respondent's adjustment is to decrease the amount of income attributable to export receipts 71 T.C. 357">*361 and, consequently, decrease the amount of the commission payable to the DISC subsidiary computed under section 994(a)(2), which petitioner is entitled to deduct in computing its taxable income. ^{51978 U.S. Tax Ct. LEXIS 13">*23} According to respondent's computation, for the year ended October 31, 1972, petitioner's DISC subsidiary would have realized no income attributable to export receipts and would, therefore, not have been entitled to any DISC commission under section 994(a)(2). ^{61978 U.S. Tax Ct. LEXIS 13">*24} For the year ended October 31, 1973, according to respondent's computation, petitioner's DISC subsidiary realized income attributable to export receipts in the amount of $ 1,251,971 and, under section 994(a)(2), was entitled to a commission of half of this amount, or $ 625,986.

On its Federal corporate income tax return for each year here in issue, petitioner deducted the amount of the log commission paid to its DISC subsidiary.

Section 631(a)^{71978 U.S. Tax Ct. LEXIS 13">*26 1978 U.S. Tax Ct. LEXIS 13">*27} allows a taxpayer to elect to consider the 71 T.C. 357">*362 cutting of timber as a sale or exchange of a section 1231 asset. Added to the Code by the Revenue Act of 1943, the predecessor of section 631 was intended to remove tax considerations as a factor in the decision of a timber grower whether to sell his land or his standing timber or to harvest the timber himself. Prior to enactment of this section, income realized from the cutting of timber was taxed as ordinary income even though much of the income might have been attributable to timber growth over a substantial period of time. An outright sale of the land with the standing timber or a sale of the uncut timber, however, could result in a capital gain to the taxpayer. To eliminate the discrimination against taxpayers who choose to cut their own timber, Congress provided for an election, pursuant to which a taxpayer who desires to sell his own timber may treat the cutting of timber as a sale or exchange. 1978 U.S. Tax Ct. LEXIS 13">*25 See S. Rept. 627, 78th Cong., 1st Sess. (1943), 1944 C.B. 973">1944 C.B. 973, 993. The gain realized under section 631 is the excess of the fair market value of the timber (determined as of the first day of the taxable year in which the timber is cut) over its adjusted basis for depletion in the hands of the taxpayer. The third sentence of section 631(a) provides that if the section 631 election is made, the fair market value of the timber "shall thereafter be considered as the cost of such cut timber to the taxpayer for all purposes for which such cost is a necessary factor." ⁸Section 1.631-1(e)(1), Income Tax 71 T.C. 357">*363 Regs., ^{91978 U.S. Tax Ct. LEXIS 13">*28} provides that when a taxpayer has made an election under section 631(a), gain realized from the sale of the products of the timber, whether in the form of logs, lumber, or manufactured products, shall be accorded ordinary income treatment. In determining the cost of the products sold, the fair market value of the timber shall be treated as its costs, in lieu of the actual cost or other basis of the timber.

In 1971, as part of the Revenue Act of that year (H.R. 10943, 92d Cong., Pub. L. 92-178), Congress enacted the DISC provisions. These provisions were enacted to provide tax incentives for domestic firms to increase their exports and to remove discrimination against United States corporations that choose to export through United States corporations, rather than through foreign subsidiaries. See H. Rept. 533, 92d Cong., 1st Sess. (1971), 1972-1 C.B. 498, 529. The vehicle chosen for these purposes was the deferral of profits realized by a new type of corporation, the domestic international sales corporation, or DISC. A DISC is a domestic corporation, the income of which is primarily derived from export transactions and which acts as the selling arm of a domestic 1978 U.S. Tax Ct. LEXIS 13">*29 corporation producing products for export. See sec. 992(a). A DISC, itself, is not subject to taxation. Sec. 991. Instead, the tax is imposed at the shareholder level. It was the intent of the statute to encourage exports by generally taxing its shareholder currently on only one-half of a DISC's profits whether or not actually distributed, and not taxing the other half to the shareholder until it is actually distributed. Sec. 995(b)(1)(F).

Section 994(a) sets forth the rules for determining the permissible profits which a DISC may earn as the result of sales of products acquired from its parent corporation. Section 994(a) refers to sales to a DISC by a related supplier, but section 994(b)(1) specifically empowers the Secretary to prescribe 71 T.C. 357">*364 regulations consistent with the provisions of section 994(a) in the case of commissions, rather than sales. Petitioner's DISC subsidiary sold logs for export on a commission basis. Section 1.994-1(d)(2), Income Tax Regs., in essence provides that the amount of income that can be earned by a DISC acting as a commission agent is to be determined as if the DISC's supplier had sold the export property to the DISC and the DISC in turn had sold 1978 U.S. Tax Ct. LEXIS 13">*30 it to a third party.

Under the commission agreement in effect between petitioner and its DISC subsidiary, petitioner was obligated to pay a DISC commission equal to the maximum amount permitted to be received by a DISC subsidiary under the inter-company pricing rules of section 994. Petitioner determined that the "50 percent of the combined taxable income attributable to qualified export receipts" method of computing the DISC commission as authorized by section 994(a)(2)¹⁰ resulted in the maximum permissible commission. Section 1.994-1(c)(6), Income Tax Regs., sets forth the rules governing computation of the combined taxable income. Subsection (ii) provides:

(ii) Cost of goods sold shall be determined in accordance with the provisions of sec. 1.61-3. See sections 471 and 472 and the regulations thereunder with respect to inventories. With respect to property to which an election under section 631 applies (relating to cutting of timber considered as a sale or exchange), cost of goods sold shall be determined by applying sec. 1.631-1(d)(3) and (e) (relating to fair market value as of the beginning of the taxable year of the standing timber cut during the year considered as its 1978 U.S. Tax Ct. LEXIS 13">*31 cost). [Emphasis supplied.]

Respondent contends that his method of computation of petitioner's DISC subsidiary's income attributable to qualified export receipts is in accordance with section 1.994-1(c)(6)(iii) and section 1.631-1(d)(3) and (e), Income Tax Regs. See nn. 8 & 9.

Petitioner argues that respondent in his computation has overlooked the portion of section 1.631-1(d)(3), Income Tax Regs., which states "for which such cost is a necessary factor." Petitioner contends that "such cost" is not a necessary factor in determining the combined taxable income of it and its DISC attributable to "qualified export receipts." Petitioner argues that "receipts" are not produced by cutting timber and that to apply the regulations as respondent does have the effect of 71 T.C. 357">*365 double taxation of the long-term increment in the value of the timber. We find no merit to petitioner's contention. "Qualified export receipts" in this case basically are the sales price of the logs sold on the export market. To determine the combined taxable income derived from these sales (that is, the income without splitting the profits between petitioner and its DISC) it is necessary to reduce the receipts 1978 U.S. Tax Ct. LEXIS 13">*32 from sales by the costs of the logs sold and a part of that cost is the timber cost. Therefore, the "timber cost" is a necessary factor to determine the "combined taxable income" referred to in section 994(d)(2). Respondent's computation is clearly correct under the provisions of section 1.631-1(d)(3) and (e) and section 1.994-1(c)(6), Income Tax Regs.

Petitioner contends that if we construe these regulations as respondent contends they should be construed, section 1.994-1(c)(6), Income Tax Regs., is invalid because it is inconsistent with the purposes of section 631 and the DISC provisions. Petitioner argues that respondent's method of computation denies Longview Fibre the full benefit of the combination of the section 631 and DISC incentives, since only the gain derived from the timber processing, and not the gain realized as a result of timber growth, is thereby eligible for the export incentive provided by the DISC provisions. This treatment, petitioner argues, is contrary to the purpose of the DISC provisions. In our view, petitioner is seeking in effect to reduce its ordinary income by an excessive commission to its DISC computed by using as cost of goods sold its depletion 1978 U.S. Tax Ct. LEXIS 13">*33 basis in the timber rather than the 631(a) cost. ^{111978 U.S. Tax Ct. LEXIS 13">*34} In effect, petitioner is seeking to have an extra 71 T.C. 357">*366 benefit from its section 631 election until such time, which may be far into the future, as it is taxable on the deferred half of its DISC income. In our view, such an extra benefit is not one of the incentive benefits of either section 631 or the DISC provisions. We find section 1.994-1(c)(6)(ii), Income Tax Regs., as interpreted by respondent, to be valid.

Petitioner argues that in effect having an extra benefit from its election under section 631 is not inconsistent with the intent of the DISC provisions. Petitioner contends that some assets may at the same time constitute qualified export assets within the meaning of section 993(b)(2), ^{121978 U.S. Tax Ct. LEXIS 13">*36} the gains from which are eligible for DISC deferral, and section 1231 assets, the gains from which are taxed at capital gains rates. While it is true that assets in the nature of section 12311978 U.S. Tax Ct. LEXIS 13">*35 assets fall within the ambit of "qualified export assets" in section 993(b)(2), the intercompany pricing rules of section 994¹³ do not apply to the sales of all qualified export assets. Rather, they apply only to a particular type of qualified export asset known as "export 71 T.C. 357">*367 property," a term defined by section 993(c). ¹⁴ The section 993(c) definition of export property does not include assets in the nature of section 1231 property. Consequently, petitioner's argument that Congress contemplated the combination of capital gains from the sale of section 1231 assets with DISC deferral is incorrect.

Section 631(a) and sections 1.631-1(d)(3), 1.631-1(e), and 1.994-1(c)(6)(ii), Income Tax Regs., clearly provide that in computing the commissions payable to its DISC subsidiary petitioner must include, as the costs of goods sold, the fair market value of timber as of the first day of the taxable 1978 U.S. Tax Ct. LEXIS 13">*37 year. We consider these regulations to be valid. We therefore hold for respondent on the only issue before us. However, because of other adjustments,

Decision will be entered under Rule 155.