103 T.C. 656">*657 OPINION

Ruwe, Judge: Respondent determined deficiencies in petitioner's Federal income taxes and additions to tax as follows:

The sole issue for decision is whether petitioner may deduct interest owed to its foreign 1994 U.S. Tax Ct. LEXIS 79">*82 parent in the tax year in which it was accrued, or whether section 267¹ requires that the deduction be deferred until the interest is actually paid. ²

The parties submitted this case fully stipulated. The stipulation of facts and attached exhibits, first supplemental stipulation of facts, settlement stipulation, and first supplemental settlement stipulation are incorporated herein by this reference.

Petitioner is an affiliated group of corporations that timely filed consolidated U.S. Corporation Income Tax Returns for the periods at issue. Tate & Lyle, Inc. (TLI), is the common parent of the affiliated group. TLI is incorporated in, and has its principal office in, Delaware. Refined Sugars, Inc. (RSI), is one of the 1994 U.S. Tax Ct. LEXIS 79">*83 members of petitioner's affiliated group.

During the periods at issue, Tate & Lyle plc (PLC) was a publicly traded United Kingdom corporation and was the parent corporation of the worldwide group of Tate & Lyle companies. PLC indirectly owned 100 percent of TLI and RSI. PLC, TLI, and RSI were members of the same controlled group of corporations as defined in section 267(f).

TLI and RSI were U.S. residents, and PLC was a U.K. resident, as defined in the Convention for the Avoidance of Double Taxation, Dec. 31, 1975, U.S.-U.K., 31 U.S.T. 5668 (treaty). PLC, TLI, and RSI were entitled to all the benefits of the treaty. At no time during the periods at issue did PLC maintain a permanent establishment or engage in a trade or business in the United States.

PLC made interest-bearing loans to TLI and RSI. RSI borrowed $ 21 million on April 4, 1985, from PLC for the purpose of acquiring the assets of Great Western Sugar Co. TLI borrowed $ 27 million on September 30, 1985, from PLC for the purpose of acquiring Vigortone Pacific Molasses Co. Additionally, PLC made short-term loans to TLI and RSI. The interest PLC received from TLI and RSI was U.S.-source income that was not effectively1994 U.S. Tax Ct. LEXIS 79">*84 connected with PLC's conduct of a trade or business in the United States. The interest PLC received was exempt from taxation in the United States under Article 11(1) of the treaty, 31 U.S.T. at 5680.

For financial reporting purposes, PLC accrued the interest receivable from TLI and RSI. As required under the income tax laws of the United Kingdom during the periods at issue, PLC reported interest income from TLI and RSI when it was actually received. In 1993, the income tax laws of the United Kingdom were changed, providing that interest income received from foreign sources is subject to tax when the interest accrues rather than when it is received.

In accordance with their methods of accounting, TLI and RSI accrued the interest due on the loans from PLC and 103 T.C. 656">*659 charged the accrued interest to an account called "Accrued Interest Payable". In the taxable periods corresponding to the periods that TLI and RSI accrued the interest, petitioner deducted the accrued interest on its consolidated tax returns. TLI and RSI paid interest to PLC during the tax period following the accrual. ³

1994 U.S. Tax Ct. LEXIS 79">*85 Respondent disallowed the accrued interest expense deductions petitioner claimed on its consolidated returns on the grounds that the interest should have been deducted in the period in which it was actually paid, not in the period in which it was accrued. In the notice of deficiency, respondent computed the adjustment to petitioner's taxable income as follows:

Section 267 generally requires taxpayers to defer deductions for amounts payable to a related person until the amount is includable in the recipient's gross income. ⁴ The purpose underlying section 267 is to prevent the use of differing methods of reporting income for Federal tax purposes in order to obtain artificial deductions.

It was recognized that there were instances where an individual on the accrual method became indebted to a creditor with whom he enjoyed a special relationship, such as a member of his family, or to a corporation he controlled, and his creditor reported income1994 U.S. Tax Ct. LEXIS 79">*86 on the cash method. Thereafter, 103 T.C. 656">*660 as interest became due on the debt, the debtor on the accrual method reported the interest as a deduction for income tax purposes, but he did not make any actual payment to his creditor. Since the creditor was on the cash method, he reported no income. The debtor would consequently gain the benefit of a current deduction, whereas the related creditor would defer income recognition until the year of receipt of actual payment. Sometimes the sum involved would escape income taxation altogether because the payment was timed to a year when the creditor had offsetting losses. [Metzger Trust v. Commissioner, 76 T.C. 42">76 T.C. 42, 76 T.C. 42">75-76 (1981), affd. 693 F.2d 459">693 F.2d 459 (5th Cir. 1982); fn. ref. omitted.]

The specific matching provisions of section 267 are in subsection (a)(2), which provides:

(2) Matching of deduction and payee income item1994 U.S. Tax Ct. LEXIS 79">*87 in the case of expenses and interest. -- If --

(A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and

(B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b),

Chiechi, J., concurring:

I write separately to explain that I concur in the result reached by the majority and its holding that, to the extent section 1.267(a)-3, Income Tax Regs., requires petitioner to deduct interest payable to PLC using the cash method, it is invalid because it does not apply the matching principle of section 267(a)(2). However, I do not agree with, and therefore do not join in, the majority's conclusion that, even if that regulation were valid, its retroactive application from the date it was issued on December 31, 1992, to petitioner's taxable years ended September 29, 1985, September 28, 1986, and September 26, 1987, violates 103 T.C. 656">*680 the Due Process Clause of the Fifth Amendment to the Constitution.

Chabot, Cohen, and Wells, JJ., agree with this concurring opinion.

Swift, J., dissenting:

At the risk of oversimplifying what the majority opinion and the parties in this case apparently view as a complicated question of statutory interpretation, I offer the following comments.

1994 U.S. Tax Ct. LEXIS 79">*131 As I read and understand the relevant statutory scheme, I believe the majority opinion reads or defines the "matching principle" of section 267(a)(2) too narrowly. Also, in interpreting the reference in section 267(a)(3) to the "matching principle" of section 267(a)(2), the majority confuses the "matching principle" with the specified reason or cause for a mismatch that, under section 267(a)(2), triggers the correction contemplated by section 267.

The general matching principle of section 267 may be simply stated: mismatches in the Federal income tax reporting and treatment of associated items of income and expense between related parties are generally to be avoided. Under section 267(a)(2), which applies generally where both parties are domestic taxpayers, the matching principle will be triggered and section 267 will correct a mismatch only where the "reason" (see the express language of section 267(a)(2)(A)) or the cause for the mismatch is a difference in the "accounting method" used by the related parties. That specified reason or cause for a mismatch (namely, a difference in accounting method) that triggers corrections under section 267(a)(2)(A) is not part of the "matching1994 U.S. Tax Ct. LEXIS 79">*132 principle" itself. Rather, it is only the "trigger" -- the specified reason or cause -- for section 267 corrections where related domestic taxpayers are involved.

In 1986, Congress added section 267(a)(3) in recognition of the fact that (where a domestic taxpayer and a related foreign party are involved) the reason or cause for a mismatch may well be something other than a difference in an accounting method (e.g., a treaty provision). Section 267(a)(3) clarifies and expands the scope and reach of the matching principle of section 267 to include other situations where the 103 T.C. 656">*681 matching principle is violated (i.e., other reasons and causes for mismatches) as between domestic taxpayers and related foreign parties. Rather than attempt to anticipate and to specify in section 267 other reasons and causes for mismatches as between domestic taxpayers and related foreign parties, Congress provided in section 267(a)(3) that respondent by legislative regulations is to provide the other reasons and causes for mismatches between domestic taxpayers and related foreign parties that appropriately trigger corrections under section 267.

Respectfully, in my opinion, it is apparent that a treaty1994 U.S. Tax Ct. LEXIS 79">*133 may represent the reason and cause for a mismatch in the tax reporting and treatment of items of income and expense as between domestic taxpayers and related foreign parties, and the conclusion is compelling that respondent has been delegated regulatory authority under section 267(a)(3) to provide that such a reason and cause for a mismatch will trigger the correction contemplated by section 267.

The fact that a treaty constitutes the reason and cause for the mismatch at issue in this case, rather than a method of accounting, neither alters the fact of the mismatch, the significance and effect of the mismatch, the policy of section 267 to correct mismatches between related parties, nor the appropriateness of the correction respondent seeks to make in this case. Both reasons for a mismatch are covered by section 267. A mismatch caused by reason of a difference in a method of accounting is covered by section 267(a)(2). A mismatch caused by reason of a treaty is covered by the legislative regulations promulgated under section 267(a)(3).

Alternatively, if the majority is correct and if the "accounting method" is part of the "matching principle" itself (and not just the specifically1994 U.S. Tax Ct. LEXIS 79">*134 stated reason for the type of mismatch that is corrected under section 267(a)(2)), I would then conclude that the treaty provision at issue in this case constitutes a "treaty-mandated" method of accounting, and I would sustain respondent's adjustment on the ground that the mismatch in question was caused "by reason of" a difference in the method of accounting for the interest income. 103 T.C. 656">*682 Under this alternative approach, the correction respondent has made in this case under section 267 would also be sustained.

Parr, J., agrees with this dissent.

Gerber, J., dissenting:

I respectfully dissent from the majority opinion. Although the profusion of concurring views about and distractions from the "majority" opinion somewhat obscure its thrust, the ostensible plurality favors either invalidating section 1.267(a)-3(c)(2), Income Tax Regs., and/or holding that the retroactive application of the regulation, if assumed valid, violates the Due Process Clause of the Fifth Amendment to the Constitution.

A. Invalidation of Section 1.267(a)-3(c)(2), Income Tax Regs. -- I disagree with the majority's invalidating the regulation for the following reasons: (1) The regulation is1994 U.S. Tax Ct. LEXIS 79">*135 a reasonable interpretation of the existing law, and its invalidation would cause anomalous results; (2) the U.S.-U.K. Income Tax Treaty ¹ does not characterize or recharacterize the (interest) income; instead, it renders it exempt from tax if and when it is otherwise recognizable; and (3) the legislative history supports the substance of the regulation as promulgated.

(1) Section 1.267(a)-3(c)(2), Income Tax Regs., Is a Reasonable Interpretation of the Law and Is Thus Valid -- Section 267 requires a matching of deduction and income items to prevent artificial deductions from occurring when related parties have different accounting methods. Majority op. p. 659. That purpose is accomplished through section 267(a)(2), which prohibits a deduction until1994 U.S. Tax Ct. LEXIS 79">*136 such time as the income is recognizable by the payee.

The majority, although supplying appropriate case precedent by which to consider a regulation, has not sufficiently explained why section 1.267(a)-3(c)(2), Income Tax Regs., does not constitute a reasonable interpretation of congressional intent underlying section 267. This is especially so 103 T.C. 656">*683 because the example contained in the legislative history was followed in the questioned regulation.

But for the U.S.-U.K. treaty, the majority agrees with respondent's position that, if sections 881(a)(1) and 1442(a) constitute a method of accounting, section 267(a)(2) requires actual payment before a domestic payor would be entitled to deduct interest payable to a foreign payee. Accordingly, if interest income was not excludable from tax under the treaty, the majority agrees with respondent's position that no deduction would be permissible until the interest was paid. ² In that regard, the parties in this case are and were subject to section 267(a)(2), irrespective of the promulgation of section 1.267(a)-3(c)(2), Income Tax Regs.

1994 U.S. Tax Ct. LEXIS 79">*137 Two years after enacting section 267(a)(2), Congress, however, acknowledging that there may be differences when foreign payees are involved, provided in section 267(a)(3) that the Secretary promulgate regulations to accomplish the same objective (i.e., matching principles) as in section 267(a)(2) where foreign payees are involved. Drawing upon the explanation and example contained in the legislative history for section 267(a)(3), the Secretary promulgated section 1.267(a)-3(c)(2), Income Tax Regs., requiring the cash method approach to deductibility by the payor even though the foreign payee were exempt from U.S. taxation. That regulation section is limited to interest income and not to income items in general. ³

1994 U.S. Tax Ct. LEXIS 79">*138 Section 267(b), to some extent, defines the breadth of section 267 by extending it to various related parties. Further, the reference to foreign payees in section 267(a)(3) reflects congressional intent that they be subjected to the matching principles of section 267(a)(2). The majority's holding that a payor is not subject to section 267 because the income would be exempt from tax when paid circumvents that congressional intent. More specifically, Congress did not relieve taxpayers 103 T.C. 656">*684 from the requirements of section 267 where one of the related members is tax-exempt under section 501. See sec. 267(b)(9). It, therefore, does not follow that, if an entity is exempt from tax and the related entities are subject to section 267, an otherwise taxable entity that is exempt from some portion of its income, especially under a treaty, would result in the related entities' not being subject to section 267. Although the majority attempts to technically distinguish between an exempt organization and being exempt from tax, it has not provided a congressional purpose for making such a distinction here. Majority op. p. 665 note 10. In that same vein, how would the majority's holding1994 U.S. Tax Ct. LEXIS 79">*139 affect domestic taxpayers if the amount received is exempt from tax? For example, the "payee" may receive compensation for injuries or sickness which is exempt from income under section 104. ⁴

(2) The U.S.-U.K. Income Tax Treaty -- The majority concludes that, because the U.S.-U.K. treaty excludes the interest from the foreign payee's gross income, such income will never be subject to the accounting method contained in sections 881(a)(1) and 1442(a). I agree that the U.K. company will have no U.S. tax liability with respect to the interest; however, I must disagree with the majority's conclusion that, because the income is tax exempt, it is or becomes nonexistent for purposes of the accounting method requirements of sections 881(a)(1), 1442(a), and 267. The character of income is not changed simply because a treaty provides relief from part or all of the tax of one of the treaty countries. 1994 U.S. Tax Ct. LEXIS 79">*140 Rather, the U.S.-U.K. treaty simply has the effect of eliminating the U.S. tax.

The majority has failed to state or interpret the language or intent of the treaty in question.

Any effort to ascertain the intent of the parties to any agreement must begin with the language in the agreement itself. The plain meaning of treaty language controls unless "application of the words of the treaty according to their obvious meaning effects a result inconsistent with the intent or expectations of its signatories." Sumitomo Shoji America, Inc. v. Avagliano, 457 U.S. 176">457 U.S. 176, 457 U.S. 176">180 (1982), quoting Maximov v. United States, 373 U.S. 49">373 U.S. 49, 373 U.S. 49">54 (1963). [Rust v. Commissioner, 85 T.C. 284">85 T.C. 284, 85 T.C. 284">288 (1985).]

Additionally, it should be noted that --

103 T.C. 656">*685 In construing a treaty, courts should give great weight to the meaning ascribed by the Government departments charged with negotiation and enforcement of the treaty. Kolovrat v. Oregon, 366 U.S. 187">366 U.S. 187, 366 U.S. 187">194 (1961); Factor v. Laubenheimer, 290 U.S. 276">290 U.S. 276, 290 U.S. 276">295 (1933); State of Minnesota v. Block, 660 F.2d 1240">660 F.2d 1240, 660 F.2d 1240">1258 (8th Cir. 1981).1994 U.S. Tax Ct. LEXIS 79">*141 * * * [Id.]

In this regard, petitioner did not advocate the legal analysis used by the majority to reach its conclusion that section 267 was inapplicable or that the regulation in question is invalid. Conversely and more significantly, respondent, on brief, did not even address the legal theory of the majority. ⁵

As a matter of current law, "the relationship between a provision of a treaty and any law of the United States affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being a treaty or law." Sec. 7852(d)(1); see also sec. 894(a). Under that standard, courts should attempt to harmonize statutes and treaties under the same rules as are applied to seemingly conflicting statutes. See Whitney v. Robertson, 124 U.S. 190">124 U.S. 190 (1888). ⁶ It is unlikely that a statute or treaty was intended to be1994 U.S. Tax Ct. LEXIS 79">*142 abrogated or modified by a subsequent statute or treaty without some acknowledgment by Congress. See, e.g., Cook v. United States, 288 U.S. 102">288 U.S. 102, 288 U.S. 102">120 (1933). Here, the majority has, in a rote manner, used the income exemption feature of the treaty to relieve domestic taxpayers from the congressionally intended requirements of section 267 without any showing of how such a result serves congressional intent.

The majority's holding is wholly dependent upon its interpretation of the section 267 "includible in gross income" language and reasoning that the treaty, with the assistance of section 894, causes the income not to be gross income, and, therefore, section 267 does not apply. The majority's unprecedented and out-of-context use of a few words from the statute and treaty results in a non sequitur. To the extent that the majority holds that the treaty or section 894 redefines1994 U.S. Tax Ct. LEXIS 79">*143 the term "interest income" as no longer constituting income or gross income, the majority's reasoning is faulty and without support. The majority's reasoning is based upon its own 103 T.C. 656">*686 novel axiom that exempting income from taxation causes it to no longer be income or gross income. ⁷

Suppose, instead, that the treaty provided for a rate reduction from 30 to 5 percent. ⁸ There is no doubt that, despite its lower tax rate, the interest remains income. In the same1994 U.S. Tax Ct. LEXIS 79">*144 vein, if one-half of the income was exempt from tax, all of the interest would remain income, but only one-half would be subject to tax. In this case, because interest income was made exempt from the U.S. tax, the majority finds no matching or need to match because there is no income by virtue of its total exclusion. The majority, by use of language from the treaty and section 894, inexplicably removes the taxpayers in this case from the requirements of section 267. ⁹

1994 U.S. Tax Ct. LEXIS 79">*145 The agreement between the United States and the United Kingdom to exempt the foreign payee from U.S. tax does not relieve the parties from the requirements of section 267 or vary cash method accounting principles mandated by Congress and implemented in the regulations by the Secretary. The treaty does not change the accounting method; rather, it determines just which treaty country will ultimately tax the income. The United Kingdom will properly tax the foreign 103 T.C. 656">*687 payee's interest because it is income. The treaty's role is not to characterize or recharacterize income as "not being income"; instead, it simply frees it, ultimately, from U.S. tax.

Finally, the effect of a tax treaty should not be considered until after a determination is made under the tax law of the respective nations. ¹⁰ In other words, one must first determine if the item is income, and then it may or may not be exempt, depending on the treaty. In this case, it appears that the treaty section exempting the foreign affiliate from U.S. taxation on the interest was intended to avoid double taxation to the foreign affiliate because the interest income was already subject to foreign taxation. Treaties normally1994 U.S. Tax Ct. LEXIS 79">*146 deal with that concern, and there is no justification for the majority's use of treaty language to color or characterize the nature of income of one of the treaty nations. Here, use of the U.S.-U.K. treaty income exemption to preempt a method of accounting requirement under the tax law of one of the treaty nations is an illogical sequence of cause and effect and could not have represented the intent of the treaty or statute in question. Additionally, such use of a treaty's language to justify different treatment for U.S. taxpayers with similar circumstances is even more inappropriate. The accounting standard is deductibility upon payment, irrespective of whether the payee has been specifically exempted from tax upon receipt. The regulation has not gone beyond the matching principle of section 267 as suggested by the majority, but instead has adapted it for foreign payee situations as recommended by Congress.

1994 U.S. Tax Ct. LEXIS 79">*147 (3) Legislative History -- The majority notes that both the House and Senate committee reports concerning section 267(a)(3) contemplate the deductibility of "items payable to a related foreign payee even though the items are not subject to U.S. tax or generally includable in the recipient's gross income." Majority op. p. 669. In that regard, the committee 103 T.C. 656">*688 reports contain an example for purposes of implementing section 267(a)(3) that is inclusive of the requirements of the regulations promulgated by the Secretary under section 267(a)(3). The only differences between section 1.267(a)-3, Income Tax Regs., and the congressional example are that the example did not concern interest income, and the foreign payee in the example was not subject to U.S. tax because it received foreign-source income, rather than being exempted from the U.S. tax by treaty. In line with the example, the committee reports proceed with the statement that the "regulations could require the U.S. subsidiary to use the cash method of accounting with respect to the deduction of amounts owed to its foreign parent". S. Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 1, 959; H. Rept. 1994 U.S. Tax Ct. LEXIS 79">*148 99-426 (1985), 1986-3 C.B. (Vol. 2) 1, 939.

While the majority finds this legislative history "trouble-some", it reflects congressional intent and, therefore, in my view, provides substantial support and authority for the questioned regulation. The majority emphasizes that the final regulations did not include income other than interest income. The exclusion of income other than interest income is not the subject of this case. This case concerns a petitioner with interest income, and we do not have to decide whether other portions of the example or regulations should be sustained. In considering the issue before us, we must recognize that the principle of the example goes beyond and is inclusive of the requirements contained in the regulation under consideration.

(4) Conclusion -- While the majority correctly notes that "our primary inquiry is whether the regulation is not manifestly contrary to the statute and is not arbitrary or capricious", majority op. p. 666, I cannot conclude, as it does, that limiting the payor to a cash method deduction is manifestly contrary to the statutory mandate under section 267(a)(3). To the contrary, I find that 1994 U.S. Tax Ct. LEXIS 79">*149 the regulations "apply the matching principle of paragraph [(a)](2)". Sec. 267(a)(3). The substance of section 267(a)(2) is that a related party expense or interest item must be deducted by the payor when the "amount is includible in the gross income of the [payee]". Thus, the "matching principle of paragraph (2)", in substance, requires the payor to report deductions on the cash method. The regulations 103 T.C. 656">*689 promulgated under section 267(a)(3), in my view, are entirely consistent with the statutory mandate. The majority's attempt to find contradiction in "the matching principle of [section 267(a)(2)]" and the cash method requirement found in the regulations under section 267(a)(3) is, at best, one of semantics.

B. Retroactive Application Under the Circumstances Here Is Not a Violation of Due Process -- Generally, I disagree that the retroactive application of the statute and regulation here was violative of petitioner's due process because: (1) It merely clarified the application of the principles in section 267(a)(2) for foreign payees; (2) section 267(a)(2), enacted in 1984, already encompassed the foreign payee situation; (3) Congress, in enacting section 267(a)(3), 1994 U.S. Tax Ct. LEXIS 79">*150 provided examples that included the circumstances involved in this case and thereby placed petitioner on notice; (4) the regulation does not preclude a deduction; it merely concerns timing and places similarly situated taxpayers on a par and, therefore, does not cause the harsh result suggested by the majority; and (5) delay in issuance is not, per se, a denial of due process where there is no change in the law.

The majority agrees that section 267(a)(2) applies to both domestic and foreign parties. More importantly, the majority acknowledges that Congress enacted section 267(a)(3) to cause the matching principle of section 267(a)(2) to apply to foreign parties. Finally, the majority agrees that, but for the treaty, the timing provisions of sections 881(a)(1) and 1442(a) constitute the method of accounting for the interest in question under section 267. In its alternative holding, the majority's premise is that the regulation is a valid interpretation of the statute. If the majority were true to its premise or assumption, then section 267(a)(2) would have been the law when petitioner's income tax returns were filed and when the questioned regulation was issued. The majority clings1994 U.S. Tax Ct. LEXIS 79">*151 to its view concerning the effect of the treaty in order to reach the conclusion that there was a due process violation.

Considering these premises, the majority is wrong to ignore the fact that section 267(a)(2) already compelled the result that respondent clarified in section 1.267(a)-3(c)(2), Income Tax Regs. Implying that taxpayers were without guidance until 1992 when the regulation was issued overstates 103 T.C. 656">*690 the situation. Albeit legislative, the regulation at issue does not contain the promulgation of a new substantive rule as the majority suggests. In the setting of this case, we must focus on the fact that the regulation treats interest consistently with the matching principles of section 267(a)(2), as Congress mandated. The majority implies that respondent's choice to include interest in the regulation and to relieve taxpayers with deductions not involving interest from the section 267 requirements resulted in a substantive rule of law. This focus is incorrect because interest is the subject of this case, and it would have been subject to section 267(a)(2).

The time lapse between the filing of the income tax returns and the issuance of the regulation is not as 1994 U.S. Tax Ct. LEXIS 79">*152 significant in considering whether due process has been afforded in this case. Where, as here, the regulation does not change the law or establish a new substantive rule of law, the result could have been expected and is not violative of a taxpayer's right of due process. In United States v. Carlton, 512 U.S.   , 114 S. Ct. 2018 (1994), the Supreme Court, in discussing the question of reliance, quoted Justice Stone's explanation that

"Taxation is neither a penalty imposed on the taxpayer nor a liability which he assumes by contract. It is but a way of apportioning the cost of government among those who in some measure are privileged to enjoy its benefits and must bear its burdens. Since no citizen enjoys immunity from that burden, its retroactive imposition does not necessarily infringe due process. . . ." [United States v. Carlton, 512 U.S. at    , 114 S. Ct. 2018">114 S. Ct. at 2023 (quoting Welch v. Henry, 305 U.S. 134">305 U.S. 134, 305 U.S. 134">146-147 (1938)).]

In this case, the interval between the enactment of section 267(a)(2) and (3) was about 2 years. The Commissioner also issued public notice of her position between 4 and 5 years after enactment1994 U.S. Tax Ct. LEXIS 79">*153 of section 267(a)(3). Section 1.267(a)-3(c)(2), Income Tax Regs., was promulgated about 9 years and 7 years after section 267(a)(2) and (3), respectively. The tax returns in question were filed approximately 5 to 7 years before the regulation was issued. In any event, the statement of the law in the various enactments, notices, and regulations that followed section 267(a)(2) was the same law and matching principle already contained in section 267(a)(2). In these circumstances, it is curious that petitioner would have been surprised by the requirement of the regulation or that due process would be made an issue. Indeed, petitioner did not 103 T.C. 656">*691 raise or argue constitutional due process. The due process discussion is a creation of the majority and without the counsel of the parties.

By way of comparison, this Court has issued opinions deciding what the substance of a regulation would have been, but which the Secretary had failed to issue until some 8 to 18 years after Congress had so mandated. ¹¹ In those instances (involving sections 58(h) and 2032A) Congress had failed to legislate because of complexity or some other reason and mandated that the Secretary issue legislative1994 U.S. Tax Ct. LEXIS 79">*154 regulations establishing the substantive rules of law. Conversely, our issuing those substantive rules of law 8 to 18 years after congressional mandate far exceeds the period we consider here, under circumstances where the regulation merely clarifies the statute.

Finally, the majority lapses into the question of the regulation's validity in deciding whether due process has been afforded, even though it assumes the regulation to be valid. The majority, relying on United States v. Carlton, supra, decides that there was a lack of due process because the "retroactive application1994 U.S. Tax Ct. LEXIS 79">*155 is so harsh and oppressive as to transgress the constitutional limitation." Majority op. p. 674 (quoting United States v. Carlton, 512 U.S. at    , 114 S. Ct. 2018">114 S. Ct. at 2022). In this regard, the majority assumes the regulation to be neither illegitimate nor arbitrary. Although the majority's ostensible focus is intended to consider the time within which respondent acted, its reasoning lapses into and relies upon its finding that the regulation is invalid. See majority op. p. 678 note 21. Its holding that the effect of the regulation is unduly "harsh and oppressive" does not follow if the majority was true to its assumption that section 267(a)(2) would cause the same result as the regulation merely clarifies. The majority finds the regulation to be harsh and oppressive solely due to the lapse of time.

Accordingly, I must respectfully dissent from the majority's holding that section 1.267(a)-3(c)(2), Income Tax Regs., is invalid or, if valid, results in a due process violation.

103 T.C. 656">*692 Hamblen, Parker, Swift, and Parr, JJ., agree with this dissent.

Halpern, J., dissenting:

Respondent has required petitioner to defer its deductions for interest paid to its foreign parent1994 U.S. Tax Ct. LEXIS 79">*156 until such time as such interest actually was paid. Respondent has changed petitioner from the accrual method of accounting to the cash method of accounting with regard to such interest on the authority of section 267(a)(2) and section 1.267(a)-3(b), Income Tax Regs. (section 1.267(a)-3(b)). Believing that it has determined the matching principle inherent in section 267, the majority invalidates section 1.267(a)-3(b) on the basis that it violates such principle. For good measure, it states that, assuming that the regulation were not invalid, retroactive application of it to the years here in issue violates due process. I can agree on neither count and, thus, dissent.

The majority states:

The matching principle of section 267(a)(2) is that an accrual basis taxpayer is not entitled to deduct an accrued item if the accrued item is payable to a related person, and the item is not currently includable in the payee's gross income because of the payee's method of accounting. * * * When this principle applies, deductions must be deferred until the expense item is includable in the gross income of the person to whom the payment is to be made. [Majority1994 U.S. Tax Ct. LEXIS 79">*157 op. p. 661; emphasis added.]

The majority determines that the related person in this case (the foreign parent) has no gross income on account of the interest in question because of the combined terms of the treaty and the Internal Revenue Code. Majority op. p. 665. Accordingly, the majority concludes:

An overall reading of the statute and legislative history does not permit the promulgation of regulations that go beyond applying the matching principle of section 267(a)(2). [Majority op. p. 670.]

For the majority the matching principle comes into play if, and, only if, by reason of the method of accounting of the related payee, a mismatch occurs. See majority op. p. 661. For the majority, a mismatch occurs when "the item is not 103 T.C. 656">*693 includable in the payee's income during the same year that it would otherwise be deductible by the taxpayer." Majority op. pp. 667-668. The majority concludes, quite logically, that, if an item is excluded from gross income (for instance, because of a treaty), then the recipient's method of accounting for that item is irrelevant for determining gross income:

A method of accounting for income only determines when an item is includable1994 U.S. Tax Ct. LEXIS 79">*158 in income. As such, a method of accounting for gross income is irrelevant and never comes into play if the item is excluded from gross income. * * * [Majority op. p. 669.]

If, because the item is excluded from gross income, the related payee's method of accounting for the item is irrelevant to a determination of gross income, then, to the majority, a match is impossible, and the matching principle can have no application. At a purely technical level, the majority seems to be saying that it will not read the statute to require it (the majority) to make an inquiry that it views as senseless; i.e., what is a related person's method of accounting for something it doesn't have? There is, of course, a certain force to such reasoning. Were it not for another portion of section 267, I would be persuaded.

Section 267(b)(9) includes in the list of relationships that are subject to the rule of section 267(a)(2) the following:

A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) 1994 U.S. Tax Ct. LEXIS 79">*159 by members of the family of such individual; * * *

With certain exceptions, organizations to which section 501 applies (section 501 organizations) are exempt from tax. See sec. 501(a). Whether or not such organizations technically have gross income is not, I think, the point. The point is that the inclusion of section 501 organizations and their controlling persons within the relationships subject to section 267(a)(2) brings into question the unstated policy consideration inherent in the majority's technical analysis; i.e., that there is no abuse if timing makes no difference (because the item does not constitute gross income) to the recipient. Section 267(b)(9) leads to the conclusion that, at least in some 103 T.C. 656">*694 circumstances, not paying tax on the amount received is not that important to Congress. The missing piece is why not paying tax is unimportant to Congress. ¹

1994 U.S. Tax Ct. LEXIS 79">*160 The legislative history of section 267(b)(9) is not illuminating. The provision came into the Code in 1954, and it is thought to have been the legislative response to the decision of this Court in Kaplan v. Commissioner, 21 T.C. 134">21 T.C. 134 (1953). See Mertens, Law of Federal Income Taxation, Code Commentary, sec. 267(b):1, at 1332 n.6 (1989). In Kaplan, the Court allowed the taxpayer to deduct a loss under the predecessor of section 267(a)(1) on the sale of stock to a tax-exempt membership organization controlled by the taxpayer and his family, since the predecessor of section 267(b)(2) did not encompass control of a nonstock corporation. Reports of both the Committee on Ways and Means and the Committee on Finance use virtually identical language to describe the operation of new section 267(b)(9). For example, the report of the Committee on Finance states:

In transactions between related taxpayers present law denies losses on sales or exchanges of property and deductions for unpaid expenses or interest.

The House and your committee's bill tightens present law by expanding the concept of related taxpayers to include * * * (3) an exempt organization 1994 U.S. Tax Ct. LEXIS 79">*161 controlled by a person or his family. Dealings between these parties are no less subject to abuse than those covered by present law.

[S. Rept. 1622, 83d Cong., 2d Sess. 38 (1954).]

See also H. Rept. 1337, 83d Cong., 2d Sess. 32 (1954). Although section 267(b)(9) may have been enacted in response to Kaplan, there is nothing in the statute (the 1954 Code version or presently) to indicate that section 501 organizations and their controlling persons are not equally subject to both the loss disallowance rule of 267(a)(1) and the unpaid expense rule of section 267(a)(2). Indeed, the legislative 103 T.C. 656">*695 history does not differentiate between such categories in describing the operation of new section 267(b)(9). There is no case on point. I would conclude that, for whatever reason, Congress intended the rule of present section 267(a)(2) to apply to section 501 organizations and their controlling persons.

To me, the application of section 267(a)(2) to section 501 organizations and their controlling persons brings into question the implicit limitation that the majority finds in the matching principle of section 267(a)(2). Since it is unclear why section 267(a)(2) applies1994 U.S. Tax Ct. LEXIS 79">*162 to section 501 organizations and their controlling persons (which I believe it does), it is difficult for me to see how one reason for not paying tax (i.e., exemption from paying tax) should be treated differently than any other reason (i.e., the item does not constitute gross income). The majority does not tell us what policy considerations inform its judgment as to the limits of the matching principle. Given the uncertainty as to Congress' policy considerations, I think that we must accord the Treasury much leeway in writing its regulations, and I would not hold section 1.267(a)-3(b) invalid.

The majority has well stated the standard for reviewing a regulation:

In determining the validity of section 1.267(a)-3, * * * our role is limited. We ordinarily defer to the regulation if it "'[implements] the congressional mandate in some reasonable manner.'" An interpretative regulation is a reasonable implementation of the congressional mandate if it "harmonizes with the plain language of the statute, its origin, and its purpose." * * *

Where the Commissioner acts under a specific grant of authority, our primary inquiry is whether the regulation is not manifestly1994 U.S. Tax Ct. LEXIS 79">*163 contrary to the statute and is not arbitrary or capricious. [Majority op. p. 666; citations omitted.]

I would add only the following: The role of the judiciary in reviewing Treasury regulations begins and ends with assuring that the Commissioner's regulations fall within her authority to implement the congressional mandate in some reasonable manner. United States v. Correll, 389 U.S. 299">389 U.S. 299, 389 U.S. 299">307 (1967).

103 T.C. 656">*696 Given the application of section 267(a)(2) to a tax-exempt organization and its controlling persons, sec. 267(b)(9), I do not find the interest rule of section 1.267(a)-3(b) an unreasonable interpretation of the statute. That is particularly so given, as the majority acknowledges, majority op. pp. 669-670, the contemplation of just such a rule in the legislative history of section 267(a)(3). The flaw in the majority's reasoning is in its interpretation of the matching principle. Its technical analysis is insufficient to illuminate some principled distinction between the case of a tax-exempt organization and a treaty exemption. The boundaries of the matching principle are unclear because the policy behind the principle is unclear. Whatever1994 U.S. Tax Ct. LEXIS 79">*164 those boundaries are, I am not convinced that they include a tax-exempt organization and exclude a treaty exemption. To me, it is reasonable to treat such cases alike. I cannot find the regulation invalid for the reasons stated by the majority.

The majority finds

the retroactive application of section 1.267(a)-3, Income Tax Regs., to petitioner to be unduly harsh and oppressive. Accordingly, we hold that the regulation, as applied to petitioner, violates the Due Process Clause. * * * [Majority op. p. 679.]

The majority's application of a promptness requirement, as a matter of due process, to the regulations process is novel, and raises many interesting issues: e.g., what principled distinction can be drawn between interpretative regulations and administrative regulations? It suffices, however, for me to say that I do not agree that the application of section 1.267(a)-3(b) to petitioner is "so harsh and oppressive as to transgress the constitutional limitation" of due process. United States v. Carlton, 512 U.S.   ,    , 114 S. Ct. 2018">114 S. Ct. 2018, 114 S. Ct. 2018">2022 (1994) (quoting Welch v. Henry, 305 U.S. 134">305 U.S. 134, 305 U.S. 134">147 (1938)).1994 U.S. Tax Ct. LEXIS 79">*165 Simply put, petitioner was on notice of what position the regulations might take with regard to interest, and, for that reason, it is difficult for me to accord much weight to any reliance petitioner might have placed on the failure of the Treasury to state its position. The majority does not say why delay, per se, can give rise to a harsh and oppressive result, but I assume that the gravamen of its complaint is 103 T.C. 656">*697 the taxpayer's reliance on a contrary assumption. The majority acknowledges that the legislative history of section 267(a)(3) contemplates that the regulations to be issued might take just that position with regard to interest taken in section 1.267(a)-3(b). Majority op. p. 670. That being the case, and no contrary regulations having been issued in the interim, I fail to see that petitioner has a claim that rises to the level of a constitutional violation of due process. I would not hold the regulation invalid on that ground.

Hamblen and Parr, JJ., agree with this dissent.

Beghe, J., dissenting:

I respectfully dissent; we should uphold the regulation as a reasonable implementation of the matching principle in this case. In addition, we haven't received1994 U.S. Tax Ct. LEXIS 79">*166 enough information or argument to tell whether retroactive application of the regulation to this case would be unconstitutional.

As the majority opinion points out, we must determine whether section 1.267(a)-3, Income Tax Regs., is a valid exercise of the broad authority granted to the Secretary by section 267(a)(3). Majority op. p. 666. If Congress has authorized the Secretary to fill a gap in the statute, we give controlling weight to the Secretary's regulations, Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837">467 U.S. 837, 467 U.S. 837">844 (1984); United States v. Vogel Fertilizer Co., 455 U.S. 16">455 U.S. 16, 455 U.S. 16">24 (1982); Rowan Cos. v. United States, 452 U.S. 247">452 U.S. 247, 452 U.S. 247">253 (1981), unless they are arbitrary, capricious or manifestly contrary to the congressional mandate, 467 U.S. 837">Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., supra at 843-844; 455 U.S. 16">United States v. Vogel Fertilizer Co., supra at 24; National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472">440 U.S. 472, 440 U.S. 472">488 (1979).

What may be the Secretary's1994 U.S. Tax Ct. LEXIS 79">*167 less-than-perfect (or even second-best) implementation of the statutory mandate is sufficiently reasonable to prevent the regulation from being "arbitrary, capricious, or manifestly contrary to the statute." 467 U.S. 837">Chevron U.S.A. Inc. v. National Resources Defense Council, Inc., supra at 844; 440 U.S. 472">National Muffler Dealers Association, Inc. v. United States,103 T.C. 656">*698 supra at 488 ("The choice among reasonable interpretations is for the Commissioner, not the courts."). I don't believe the regulation is so obviously contrary to the statutory mandate as to be invalid when three other Judges and their adherents (all presumably having the faculty of reason) conclude that section 267(a)(3) expands the scope and reach of the matching principle of section 267 (Swift, J., dissenting op. p. 680), that the regulation implements the statute in reasonable fashion (Halpern, J., dissenting op. p. 695), and that the regulation is entirely consistent with the statutory mandate (Gerber, J., dissenting op. p. 688).

I would uphold the regulation by reading together the statute's invocation of the matching principle and Article 24(3) of the U.S.-U.K. 1994 U.S. Tax Ct. LEXIS 79">*168 Income Tax Treaty ¹ as integrated parts of an overall scheme to prevent double taxation. Both the full title of the treaty and its preamble make clear that preventing double taxation is one of the treaty's primary purposes. The treaty and our domestic law should be interpreted so as to accomplish that purpose. Maximov v. United States, 373 U.S. 49">373 U.S. 49 (1963) (purposes of U.S.-U.K. Income Tax Treaty stated in preamble do not suggest treating trust as separate taxable entity); United States v. Vetco Inc., 644 F.2d 1324">644 F.2d 1324 (9th Cir. 1981) (one of purposes of U.S.-Swiss Income Tax Treaty -- prevention of fraud -- would be ill-served by limiting means of acquiring information to those named in treaty). It is wellsettled law that, when possible, statutes should be read so as to be consistent with our treaty obligations. Weinberger v. Rossi, 456 U.S. 25">456 U.S. 25, 456 U.S. 25">33 (1982); Clark v. Allen, 331 U.S. 503">331 U.S. 503, 331 U.S. 503">508-511 (1947); Murray v. The Schooner Charming Betsy, 6 U.S. (2 Cranch) 64, 118 (1804); United States v. Palestine Liberation Org., 695 F. Supp. 1456">695 F. Supp. 1456, 695 F. Supp. 1456">1465 (S.D.N.Y. 1988).1994 U.S. Tax Ct. LEXIS 79">*169

The versions of sections 894(a) and 7852(d) in effect before their amendment in 1988 already suggested that we should consider tax treaties when interpreting tax statutes. The language 103 T.C. 656">*699 of the new version of section 894(a) supports the need to do so even more strongly: "The provisions of this title shall be applied to any 1994 U.S. Tax Ct. LEXIS 79">*170 taxpayer with due regard to any treaty obligation of the United States which applies to such taxpayer." (Emphasis added.) If the majority opinion correctly asserts (p. 664 note 8) that the changes in sections 894 and 7852(d) were made only for the purpose of clarifying the interaction between statutes and treaties, ² then the new texts imply that the 100th Congress believed that the old versions of the two sections already meant that "due regard" was to be paid to tax treaties in the application of the Internal Revenue Code. However, regardless of whether the majority are correct on this point, the Internal Revenue Code and the treaty should be interpreted harmoniously.

1994 U.S. Tax Ct. LEXIS 79">*171 Article 24(3) of the treaty, 31 U.S.T. at 5687, as of the time the treaty was adopted, displays the assumption that the "other Contracting State" -- here the United Kingdom -- would tax the recipient of U.S.-source income when the recipient received the payment. Indeed, during the years in question, the United Kingdom did tax the payments in question on a cash basis. In these circumstances, I believe that the regulation reasonably implemented the matching principle by delaying the deduction of interest expense for U.S. income tax purposes until petitioner's U.K. parent recognized the interest income in issue for U.K. income tax purposes. ³

If the retroactive application of a regulation is unconstitutional, there has been an abuse of discretion. Pacific First Fed. Sav. Bank v. Commissioner, 101 T.C. 117">101 T.C. 117, 101 T.C. 117">121 (1993). A taxpayer attempting to demonstrate an abuse of discretion, in the area of retroactivity as elsewhere, carries a heavy burden 103 T.C. 656">*700 of proof and persuasion. Id. The parties did not raise the constitutional question at trial or on brief, and respondent has not had the opportunity to bring to our attention the considerations that may support the retroactive application of the regulation. It would therefore amount to an arrogation of power by this Court to hold the regulation invalid on constitutional grounds without putting petitioner to its proof and without the benefit of respondent's views on the matter.

Gerber, J., agrees with this dissent.