104 T.C. 105">*106 HALPERN, Judge: Petitioner is the common parent corporation of an affiliated group of corporations making a consolidated return of income (the affiliated group). Respondent determined a deficiency of $ 388,992.85 in the income tax liability of the affiliated group for its taxable year ended November 1, 1986. ¹

1995 U.S. Tax Ct. LEXIS 5">*6 The only issue in dispute is whether Brown Cayman, Ltd.'s (Brown Cayman's) share of partnership income from Brinco, a Cayman Islands partnership, is subpart F income, includable in the gross income of a member of the affiliated group under section 951(a). We hold that it is.

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

A trial was held on March 9, 1993. Petitioner called no witnesses. Respondent called one: Theodore Presti. The parties had stipulated certain facts, however, and the facts stipulated are so found. The stipulation of facts and attached exhibits is incorporated herein by this reference. The following summarizes the facts relied on by us in reaching our decision.

Petitioner Brown Group, Inc. (sometimes Brown Group), is a New York corporation. At the time the petition herein was filed, petitioner's principal place of business was in St. Louis, Missouri. The following diagram facilitates an understanding of the relationships of the parties involved:

104 T.C. 105">*107

Throughout 1985 and1995 U.S. Tax Ct. LEXIS 5">*7 1986, Brown Group had divisions that sold footwear at the retail and wholesale levels, manufactured footwear, and imported footwear. Brown Group manufactured footwear in the United States and imported footwear from, among other countries, Brazil.

Brown Group International (International), a Delaware corporation, was incorporated in 1985, as a wholly owned subsidiary of Brown Group. Throughout 1985 and 1986, International was a U.S. shareholder of Brown Cayman within the meaning of section 951(b).

Brown Cayman, a Cayman Islands corporation, was incorporated in 1985. Brown Cayman was a controlled foreign corporation within the meaning of section 957(a) at all times relevant to this case.

T.P. Cayman, Ltd. (T.P. Cayman), a Cayman Islands corporation, was incorporated in March 1985.

Pidge, Inc., is a Missouri corporation; the date of its incorporation is not contained in the record.

104 T.C. 105">*108 Brinco, a partnership within the meaning of section 7701, and the regulations thereunder, was formed in the Cayman Islands in March 1985. The partners of Brinco, and their percentage interests in the net profits and losses of Brinco, were Brown Cayman, 88 percent, T.P. Cayman, 10 percent, and an1995 U.S. Tax Ct. LEXIS 5">*8 individual, Delcio Birck (Birck), 2 percent.

Prior to the formation of Brinco, Brown Group utilized independent agents to purchase footwear manufactured in Brazil. At that time, Birck, a Brazilian citizen, and Presti, a U.S. citizen, were employed by a company, Michelle Manard, which purchased footwear manufactured in Brazil on behalf of Brown Group and others. Michelle Manard "officially" charged Brown Group a 7-percent commission, although occasionally that rate was greater. Brinco was formed, among other reasons, to attract Presti and Birck to source Brazilian footwear exclusively for the Brown Group companies and to consolidate Brown Group's Brazilian buying power. Brinco was structured as a partnership, among other reasons, because: (1) Presti's salary requirements could not be satisfied within Brown Group's existing payroll structure, (2) it allowed Presti and Birck to have some entrepreneurial interest in Brinco's operations, and (3) it permitted the partners to avoid Brazilian currency controls and currency fluctuations.

During 1985 and 1986, Brinco acted as purchasing agent for International with respect to footwear manufactured in Brazil. The footwear so imported was sold1995 U.S. Tax Ct. LEXIS 5">*9 primarily in the United States. Presti was the managing partner of Brinco. As such, he was responsible for the design, manufacture, and quality control of the footwear. He also supervised Brinco's operations within Brazil.

The Brown Group companies paid Brinco a 10-percent commission for acting as their purchasing agent for footwear manufactured in Brazil. The commission was based on the purchase price of the footwear. Brinco's 1985 commission income for acting as purchasing agent for the Brown Group companies was $ 1,119,970. The Brown Group companies included the commissions paid to Brinco in their costs of goods sold.

Pursuant to negotiations among the Brinco partners, because of the uncertainty of first-year profits, for the 7-month period ending November 2, 1985, T.P. Cayman 104 T.C. 105">*109 received guaranteed payments totaling $ 151,662 ($ 21,666 a month for 7 months), instead of its share of partnership profits called for in the Brinco partnership agreement. After making guaranteed payments to T.P. Cayman, Brinco's partnership net earnings for 1985 totaled $ 917,465, which were distributed as follows:

In 1986, T.P. Cayman1995 U.S. Tax Ct. LEXIS 5">*10 received its share of partnership profits as called for in the Brinco partnership agreement (and no guaranteed payments).

Brinco was dissolved on October 31, 1987. At that time, Presti became executive vice president of International, and Birck, as an independent agent, continued to source footwear for the Brown Group companies on a commission basis.

Respondent determined that Brown Cayman's distributive share of Brinco's earnings is foreign base company sales income, includable as subpart F income in the gross income of International.

OPINION

For all relevant periods, the parties have stipulated that (1) Brown Cayman was a "controlled foreign corporation" (CFC) within the meaning of section 957(a) and (2) International was a "United States shareholder" of Brown Cayman within the meaning of section 951(b). Accordingly, International must include in its gross income its pro rata share (100 percent) of any "subpart F income" of Brown Cayman. See sec. 951(a). Subpart F income is defined in section 952 to include an item called "foreign base company income". Sec. 951(a)(2). Foreign base company income, in turn, is defined in section 954(a) to include "foreign base1995 U.S. Tax Ct. LEXIS 5">*11 company sales income". Sec. 954(a)(2). Foreign base company sales income includes, among other things: "income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with * * * the purchase of personal property from any person on behalf of a related person" where the goods are both produced and sold for use outside the country in which the CFC is incorporated. Sec. 954(d)(1). The term "related person" 104 T.C. 105">*110 is defined in section 954(d)(3). It is clear that International was a related person with regard to Brown Cayman. See sec. 954(d)(3) ("such person is a corporation which controls * * * the controlled foreign corporation"). It also is clear that Brinco earned commission income by arranging for the purchase of footwear by International. ² Brinco was a partnership of which Brown Cayman was a partner. Brown Cayman was entitled to share in the income of Brinco. Pursuant to section 702, Brown Cayman was required to take into account its distributive share of that income. ³ The narrow question we must answer is whether Brown Cayman had income "(whether in the form of profits, commissions, fees, or otherwise) derived in connection with * * * the purchase1995 U.S. Tax Ct. LEXIS 5">*12 of personal property from any person on behalf of a related person". See sec. 954(d)(1). We believe that it did.

Petitioner argues as follows: under section 954(d)(3), as in effect for the year in issue, Brinco was not a related person with regard to Brown Cayman or International. Absent such a relationship, Brown Cayman's distributive share of Brinco's income cannot be subpart F income with respect to Brown Cayman or International. Alternatively, the character of the income in question is determined at the partnership (Brinco) level, by treating Brinco as a separate entity. Consequently, the income in question is that of Brinco, not Brown Cayman. Thus, the income cannot be foreign base company sales income of Brown Cayman.

104 T.C. 105">*111 B. Respondent's Argument

Respondent agrees that, under section 954(d)(3), as in effect for the year in issue, Brinco was not a related person with regard to Brown Cayman or International. Respondent's argument is as follows: The aggregate theory of partnerships should apply in this case because that theory furthers the purposes of subpart F. Under the aggregate theory, Brown Cayman's distributive share of Brinco's income must be treated as foreign base company sales income and, consequently, subpart1995 U.S. Tax Ct. LEXIS 5">*14 F income. International, the U.S. share-holder of Brown Cayman, must include its pro rata share (100 percent) of Brown Cayman's subpart F income in its gross income under section 951(a). Respondent has not argued that Brinco is a sham.

Substantially, we agree with respondent. We believe that a close reading of the regulations under subpart F, a consideration of the structure and language of subchapter K (the partnership provisions), Congress' purpose in enacting subpart F, and certain language of section 954(d)(1) compel the result that respondent advocates.

Section 954 deals with the computation of foreign base company income, of which foreign base company sales income is a component. Sec. 954(a)(2). Section 1.954A-1, Income Tax Regs., deals with the computation of foreign base company income for taxable years of a CFC beginning after 1975 and before 1987. See sec. 1.954A-1(a), Income Tax Regs.; sec. 1.954-0T(a)(2), Temporary Income Tax Regs. Section 1.954A-1(c), Income Tax Regs., states in pertinent part:

For purposes of section 954 and this section, * * * foreign base company sales income as defined in § 1.954-31995 U.S. Tax Ct. LEXIS 5">*15 * * * shall be taken into account in determining foreign base company income after allowance for deductions properly allocable to such [category] of income. For determination of gross income and deductions for purposes of section 954, see section 952 and the regulations thereunder. * * *

104 T.C. 105">*112 Section 1.952-2(a)(1), Income Tax Regs., states in pertinent part:

the gross income of a foreign corporation for any taxable year shall, subject to the special rules of paragraph (c) of this section, be determined by treating such foreign corporation as a domestic corporation taxable under section 11 and by applying the principles of section 61 and the regulations thereunder.

Paragraph (c)(1) of section 1.952-2, Income Tax Regs., states that, as a general rule, certain subchapters of chapter 1 of the Code shall not apply. Subchapter K, chapter 1, subtitle A of the Code, sections 701 through 761 (subchapter K), is not among the excluded subchapters. Thus, by implication, subchapter K is applicable.

Section 1.952-3(a), Income Tax Regs., describes the computations that a U.S. shareholder of a CFC must make in connection with the application of section 954 and the subsequent application1995 U.S. Tax Ct. LEXIS 5">*16 of section 952. Paragraph (b) of section 1.952-3, Income Tax Regs., states the general rule. That rule is that the U.S. shareholder must determine the subpart F income of the CFC by, among other things, determining the foreign base company sales income of the CFC.

Section 1.954-3(a)(1)(i), Income Tax Regs., mirroring the statute, states that foreign base company sales income of a CFC includes, among other things, commission income derived in connection with the purchase of personal property from any person on behalf of a related person.

In summary, the cited provisions of the regulations lay out a scheme under which the U.S. shareholder of a CFC must determine the foreign base company sales income of the CFC (including the described commission income) under most of the rules applicable to a domestic corporation determining its tax liability under section 11, including the rules of subchapter K.

Subchapter K deals with the taxation of partners and partnerships.

Section 701 provides that a partnership as such shall not be subject to the income tax. Persons carrying on business as partners are liable for income tax only in their separate or individual capacities. 1995 U.S. Tax Ct. LEXIS 5">*17

104 T.C. 105">*113 Section 702(a) provides that, in determining a partner's income tax, each partner must take into account separately the partner's distributive share of items enumerated in section 702(a)(1) through (8). Under section 702(a)(7), a partner must take into account separately those items of income, gain, loss, deduction, or credit prescribed by regulations.

Section 1.702-1(a)(8)(ii), Income Tax Regs., provides that each partner must take into account separately the partner's distributive share of any partnership item that, if separately taken into account by any partner, would result in an income tax liability for that partner different from that which would result if that partner did not take the item into account separately.

Section 702(b) provides that the character of any item included in a partner's distributive share under paragraphs (1) through (7) of section 702(a) is determined as if such item were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership. Section 1.702-1(b), Income Tax Regs., provides, in pertinent part:

The character in the hands of a partner of any item of income, gain, 1995 U.S. Tax Ct. LEXIS 5">*18 loss, deduction, or credit described in section 702(a)(1) through * * * [7] shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner incurred by the partnership. * * *

Section 703(a)(1) provides that a partnership shall separately state the items described in section 702(a) in computing its taxable income.

Brown Cayman, a partner of Brinco, is a foreign corporation and, apparently, has no Federal income tax liability. Nevertheless, International, a U.S. shareholder with respect to Brown Cayman, must take into account its pro rata share of Brown Cayman's subpart F income. See sec. 951(a). Applying Federal income tax principles, International must compute those items of Brown Cayman's income that constitute subpart F income. See sec. 1.952-2(a), Income Tax Regs. Unless items that constitute, for instance, foreign base company sales income are separately stated, International will be unable to make that computation. Since, under section 951(a), International is taxed directly on its pro rata share of Brown Cayman's subpart F income, we must look to 104 T.C. 105">*114 International's tax liability to determine1995 U.S. Tax Ct. LEXIS 5">*19 whether Brinco must separately state items, such as commission income, that could constitute foreign base company sales income. To give effect to section 702(a)(7) and section 1.702-1(a)(8)(ii), Income Tax Regs., and to avoid frustrating the purpose of Congress in enacting subpart F, Brinco must separately state its commission income.

Subpart F contradicts the general rule that the shareholders of a corporation defer paying a tax on the income earned by the corporation until such income is distributed to them, usually in the form of a dividend. Subpart F was designed to remove the tax deferral benefits of certain offshore operations that Congress considered to be "tax haven" devices; i.e., foreign operations that were artificially structured to take advantage of a low (or zero) rate of foreign tax. S. Rept. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 707, 784. (S. Rept. 1881 accompanied H.R. 10650, which became the Revenue Act of 1962, Pub. L. 87-834, 76 Stat. 960, which added subpart F.)

It is important to keep in mind the method that Congress chose to meet its objectives: subpart F imposes a conduit1995 U.S. Tax Ct. LEXIS 5">*20 scheme with regard to subpart F income. Subpart F income is taxed currently to U.S. shareholders notwithstanding that no distribution of such income is made. See sec. 951. The parallel with subchapter K is obvious. Congress chose to minimize (perhaps even eliminate) the entity character of the CFC in order to tax U.S. shareholders as if they had earned directly the subpart F income earned by the CFC. It would be ironic, indeed, if one could defeat the clearly expressed intent of Congress to tax the income from the activities involved here by engaging in those activities though a form of doing business that not only is taxed on a conduit basis but whose non-tax-law character often resembles an aggregate of persons 104 T.C. 105">*115 doing business together (as mutual agents) rather than an entity. ⁴

The facts of this case show that the formation of Brinco did not significantly change the way Brown Group (through International) imported shoes manufactured in Brazil. Presti and Birck1995 U.S. Tax Ct. LEXIS 5">*21 still continued to do the actual commission agent work. They did it, however, as partners (directly or indirectly) in Brinco. Under the prior arrangement, Brown Group had paid a 7-percent commission to Michelle Manard, Presti and Birck's employer. Ostensibly, Brown Group raised its commission rate to 10 percent. However, as the owner, indirectly, of Brown Cayman, a partner in Brinco, Brown Group, was entitled to receive back the bulk of that 10 percent and, apparently, realized a net savings. Had Brown Cayman hired Presti and Birck as employees, or otherwise engaged them as agents, and collected directly from Brown Group or International a commission agent's fee, it would be clear that at least the net amount retained by Brown Cayman would be foreign base company sales income.

The law of partnerships in the Cayman Islands is derived from the law of partnerships in England. See Davies, The Legal System of the Cayman Islands 89, 188-194 (1989). Compare Partnership Law, 1983 (Cayman Islands) with Partnership Act, 1890, 53 & 54 Vic., c. 39 (Eng.). English law lends itself to the view that Brown Cayman, as a partner of Brinco, acting on its own behalf, and through its partners (its agents), 1995 U.S. Tax Ct. LEXIS 5">*22 did function as a commission agent. ⁵ The facts seem 104 T.C. 105">*116 ripe for the application of subpart F. A contrary result would lead to just the type of siphoning of profits that Congress was concerned with when it subjected foreign base company sales income to the conduit treatment of subpart F. But cf. MCA Inc. v. United States, 685 F.2d 1099">685 F.2d 1099, 685 F.2d 1099">1104-1105 (9th Cir. 1982) (remedy for loophole in subpart F "lies in new legislation, not judicial improvisation").

1995 U.S. Tax Ct. LEXIS 5">*23 E. Aggregate Versus Entity

To effectuate the purpose of Congress in enacting subpart F, we will require Brinco to state separately its commission income under section 703. What we are doing might be characterized as emphasizing the "aggregate" or "conduit" nature of Brinco, a partnership, over its "entity" nature. We have pursued a technical road in our analysis, and have avoided framing the issue in terms of aggregate versus entity. Nevertheless, and particularly in light of petitioner's argument that Brinco should be treated as a separate entity, we will address the aggregate versus entity question briefly.

Authorities on partnership taxation have stated that subchapter K does not espouse either the aggregate or the entity theory of partnerships, but rather blends the two theories. 1 McKee Nelson & Whitmire, Federal Taxation of Partnerships and Partners (hereafter McKee et al.), par. 1.02 (2d ed. 1990). We agree. Compare sec. 751 with sec. 741. Moreover, for purposes of interpreting provisions of the Code not contained in subchapter K, a partnership also may be treated either as an aggregate of its partners or as an entity distinct from1995 U.S. Tax Ct. LEXIS 5">*24 its partners. CompareCasel v. Commissioner, 79 T.C. 424">79 T.C. 424, 79 T.C. 424">433-434 (1982) (aggregate approach of regulations under section 267 appropriate) with Madison Gas & Elec. Co. v. Commissioner, 72 T.C. 521">72 T.C. 521, 72 T.C. 521">564 (1979), affd. 633 F.2d 512">633 F.2d 512 (7th Cir. 1980) (business of partnership, a business separate 104 T.C. 105">*117 from the business of the partners). The treatment of partnerships in each context must be determined on the basis of the characterization most appropriate for the situation. See H. Conf. Rept. 2543, 83d Cong., 2d Sess. (1954), 1954 U.S.C.C.A.N. 5280. H. Rept. 2543 accompanied H.R. 8300, 83d Cong., 2d Sess., which became the Internal Revenue Code of 1954.

For the reasons set forth above in our discussion of subpart F, we believe that, to accomplish the purposes of Congress in enacting subpart F, the aggregate nature of Brinco as a partnership must be emphasized. We are not here dealing with the computation of Brinco's income but with the consequence to Brinco's partners stemming from their rights under the partnership agreement to share in that income. The relationship between1995 U.S. Tax Ct. LEXIS 5">*25 the entity approach to the computation of partnership income found in sections 703 and 706 and the aggregate approach applied to the taxation of that income found in sections 701, 702, and 704 has been described by the Supreme Court as follows:

For * * * [the purpose of calculating partnership income], the partnership is regarded as an independently recognizable entity apart from the aggregate of its partners. Once its income is ascertained and reported, its existence may be disregarded since each partner must pay a tax on a portion of the total income as if the partnership were merely an agent or conduit through which the income passed. [United States v. Basye, 410 U.S. 441">410 U.S. 441, 410 U.S. 441">448 (1973); fn. ref. omitted.]

McKee et al. have characterized the Supreme Court's analysis as follows:

This analysis of the statute embodies a very clear and sharply defined separation between (1) the treatment of a partnership as a separate entity for purposes of determining its income, and (2) the taxation of partnership income, as so determined, to the partners under the conduit approach. * * * [1 McKee et al., supra par. 9.01[2], at 9-6.]

4. Application of Entity-Aggregate1995 U.S. Tax Ct. LEXIS 5">*26 Distinction in Practice

Indeed, an examination of cases requiring an entity (partnership) level determination of income shows that, once such determination is made, the partnership is ignored and the individual partners take account of such income as if they 104 T.C. 105">*118 had earned it directly. E.g., Pleasant Summit Land Corp. v. Commissioner, 863 F.2d 263">863 F.2d 263, 863 F.2d 263">272 (3d Cir. 1988), affg. in part and revg. in part T.C. Memo. 1987-469 ("After the partnership's income and deductions are calculated and reported, it is a conduit through which income and deductions are distributed to individual partners."); Davis v. Commissioner, 74 T.C. 881">74 T.C. 881, 74 T.C. 881">905-906 (1980), affd. 746 F.2d 357">746 F.2d 357 (6th Cir. 1984) (capital gains determined at partnership level retain that characterization at partner level).

Notwithstanding such shift in emphasis from an entity view at the partnership level to an aggregate view at the partner level, any characterization of the partnership's activity with regard to an item generally persists. For instance, in Goodwin v. Commissioner, 75 T.C. 424">75 T.C. 424 (1980),1995 U.S. Tax Ct. LEXIS 5">*27 affd. without published opinion, 691 F.2d 490">691 F.2d 490 (3d Cir. 1982), the taxpayer argued that we should inquire as to trade or business activity at his, the partner's, level to characterize certain deductions taken by the partnership. We declined, requiring him to treat his distributive share of the expenses as a non-deductible startup cost associated with the formation of a new (partnership) business. We held: "in the context of section 162, the character of the deductions, i.e., whether they were incurred in the course of a trade or business, must be resolved at the partnership level." 75 T.C. 424">Id. at 437.

Pertinent to the question at hand, we, and other courts, have attributed to a partner the activities and even the property of a partnership to determine whether, by virtue of such activity or property, the partner had a particular status important for determining some aspect of the partner's Federal income tax status. In Unger v. Commissioner, 936 F.2d 1316">936 F.2d 1316 (D.C. Cir. 1991), affg. T.C. Memo. 1990-15, the question was whether a Canadian resident, a limited partner in a Massachusetts1995 U.S. Tax Ct. LEXIS 5">*28 partnership, was taxable on his distributive share of a certain capital gain realized by the partnership. The question turned on whether the partner maintained a "permanent establishment" within the United States. For purposes of the case, the term "permanent establishment" meant an office or other fixed place of business. The court held that, since the partnership maintained a permanent office in Boston, the taxpayer had a permanent establishment in the United States by virtue of his interest in the partnership offices. 936 F.2d 1316">Id. at 1320; Donroy, Ltd. v. United 104 T.C. 105">*119 States, 301 F.2d 200">301 F.2d 200 (9th Cir. 1962) (similar, but with emphasis on the agency nature of the general partner's relationship to a limited partner); Johnston v. Commissioner, 24 T.C. 920">24 T.C. 920, 24 T.C. 920">923 (1955) (permanent place of business in the United States by virtue of partnership interest); Cantrell & Cochrane, Ltd. v. Commissioner, 19 B.T.A. 16">19 B.T.A. 16, 19 B.T.A. 16">24 (1930) (whether U.K. corporation, a member of a "syndicate" with an office and a place of business in the United States, and engaging in a trade or business in1995 U.S. Tax Ct. LEXIS 5">*29 the United States, either itself engaged in a trade or business in the United States or had any office or place of business therein: "In the eye of the law at least it was present here as a party to the conduct of the business of the 'syndicate' through which it established a place of business within the United States for doing a part of its business."). The situation here is analogous. Brown Cayman should be put into the shoes of Brinco for determining whether Brown Cayman was earning commission income on sales by third parties to International.

F. "[I]n connection with"

Our analysis has relied heavily on the provisions of subchapter K. Indeed, that is the path that the parties have taken, and it is supported by the weight of commentary that the issue has generated. ⁶ Before addressing one final argument of petitioner, we wish to point out that certain words of section 954(d)(1), as recently interpreted by this Court, lend support to our analysis. As stated earlier, the term "foreign base company sales income" is defined in section 954(d)(1). In pertinent part (with emphasis added), the definition includes:

income (whether in the form of profits, commissions, fees, or1995 U.S. Tax Ct. LEXIS 5">*30 otherwise) derived in connection with * * * the purchase of personal property from any person on behalf of a related person * * * [Emphasis added.]

Recently, we had the opportunity to construe the phrase "in connection with" as used in section 162(k)(1). Fort Howard Corp. v Commissioner, 103 T.C. 345">103 T.C. 345, 103 T.C. 345">351 (1994). In Fort 104 T.C. 105">*120 Howard Corp., we observed that words1995 U.S. Tax Ct. LEXIS 5">*31 in a revenue act should be interpreted in their ordinary, everyday sense. 103 T.C. 345">Id. at 351. We stated that the phrase "in connection with" had been, and should be, interpreted broadly. 103 T.C. 345">Id. at 352. ⁷ We said that the phrase means "associated with, or related". Id. We consulted a dictionary, and said: "Events or elements are 'connected' when they are 'logically related' to each other." Id. (quoting Webster's Third New World Dictionary (1986)). That relationship exists here. Brown Cayman was a CFC. Its distributive share of partnership profits was, by design and reality, connected to and dependent on purchases made on behalf of a party related to Brown Cayman.

1995 U.S. Tax Ct. LEXIS 5">*32 G. Brinco as a Related Person

Finally, we wish to dispose of one argument made by petitioner: viz, that, for the year in question, Brinco was not a related person with regard to Brown Cayman or International. That is true; nonetheless, it is irrelevant. Nothing here turns on whether Brinco is a related person with regard to either Brown Cayman or International. We are dealing here with that part of the definition of foreign base company sales income that involves "the purchase of personal property from any person on behalf of a related person". Sec. 954(d)(1). The inquiry is whether Brown Cayman, through Brinco, purchased footwear on behalf of International. International is the related person, and there is no argument about that. The only possible entity here that can be a controlled foreign corporation is Brown Cayman. As stated, nothing turns on whether Brinco is a related person.

It is true that the definition of related person in section 954(d)(3) was amended in 1986 to include partnerships controlled by or controlling a CFC within the definition of related persons with regard to such CFC. Tax Reform Act of 1986, Pub. L. 99-514, sec. 1221(e)(1), 100 Stat. 2085, 2553-2554. 1995 U.S. Tax Ct. LEXIS 5">*33 Nevertheless, the relevant definition of what constitutes foreign base company sales income ("income * * * derived in connection with * * * the purchase of personal property from any person on behalf of a related person") was not amended. 104 T.C. 105">*121 Sec. 954(d)(1) (emphasis added). Nothing here was purchased on behalf of Brinco; indeed, Brinco did the purchasing on behalf of International.

For the reasons stated, we find that Brown Cayman had commission income derived in connection with the purchase of personal property from any person on behalf of International. We hold that such income is foreign base company sales income under section 954(d)(1) and that International must include in its gross income subpart F income as determined by respondent.

Decision will be entered for respondent.

HAMBLEN, PARKER, COHEN, SWIFT, PARR, and BEGHE, JJ., agree with this majority opinion.

WELLS, J., did not participate in the consideration of this opinion.

RUWE, J., concurring: I agree with the majority's conclusion that Brown Cayman's distributive share of Brinco's partnership income is subpart F income. However, I believe that there are1995 U.S. Tax Ct. LEXIS 5">*34 technical problems with the majority's reliance on subchapter K and the related aggregate versus entity analysis. These problems can be avoided by simply applying the literal terms of section 954. I will first address the problems and then the solution.

Section 702 provides that each partner must account separately for certain specifically enumerated types of partnership income, losses, and deductions that are described in section 702(a)(1) through (7). If a partnership item is not described in section 702(a)(1) through (7), section 702(a)(8) provides that a partner is to account for his distributive share as "taxable income or loss" from the partnership 104 T.C. 105">*122 "exclusive of items requiring separate computation under other paragraphs of this subsection." Sec. 702(a)(8).

Section 702(b) provides that the character of any item of income that is included in a partner's distributive share under section 702(a)(1) through (7) "shall be determined as if such item were realized directly from the source from which realized by the partnership". Section 702(b)'s character pass-through requirement does not apply to the items covered by section 702(a)(8). 1995 U.S. Tax Ct. LEXIS 5">*35 The majority uses section 702(b) to characterize Brown Cayman's distributive share of income from Brinco as commissions earned on the purchase of footwear. To do this, Brinco's commission income must be an item described in section 702(a)(1) through (7). Paragraphs (1) through (6) are clearly inapplicable. The majority focuses on paragraph (7) to impute the character of Brinco's commission income to Brown Cayman. Paragraph (7) provides that a partner must separately account for "other items of income * * * to the extent provided by regulations".

The regulation upon which the majority relies is section 1.702-1(a)(8)(ii), Income Tax Regs.Section 1.702-1(a)(8)(ii), Income Tax Regs., provides that "Each partner must take into account separately his distributive share of any partnership item which if separately taken into account by any partner would result in an income tax liability for that partner different from that which would result if that partner did not take the item into account separately." (Emphasis added.)

In order for section 1.702-1(a)(8)(ii), Income Tax Regs., to apply, the tax liability of the "partner" must be affected by whether the partnership item1995 U.S. Tax Ct. LEXIS 5">*36 is separately taken into account. The problem with applying this regulation to the facts in the instant case is that Brown Cayman is the partner in question, but it has no tax liability. Even if we treat Brown Cayman as if it were a domestic corporation liable for U.S. tax, its tax liability is in no way affected by separately accounting for and characterizing the partnership income attributable to Brinco's commissions. Brown Cayman's hypothetical tax liability would still be based on the income it derived from its distributive share of partnership income. Sec. 61(a)(13). That distributive share of partnership income would include partnership income attributable to Brinco's purchase of footwear. However, the separate characterization of Brown Cayman's income from Brinco as commission 104 T.C. 105">*123 income would have no affect on Brown Cayman's actual or hypothetical tax liability. ¹1995 U.S. Tax Ct. LEXIS 5">*37 It follows that section 1.702-1(a)(8)(ii), Income Tax Regs., does not apply, and therefore the result the majority arrives at is not supported by its technical analysis. ²

2. Aggregate vs. Entity

While there may be areas in the law of partnership taxation where the aggregate versus entity issue still exists, I do not believe there is any remaining issue with respect to the type of specific partnership income items that must be characterized by individual partners as if they had realized1995 U.S. Tax Ct. LEXIS 5">*38 the income directly from the source from which realized by the partnership. Congress has specifically provided statutory rules in section 702(a)(1) through (8) and subsection (b) that answer this question. ³ In section 702(a)(7), Congress also gave the Department of the Treasury broad regulatory authority to specify additional partnership items that must be separately accounted for and characterized at the partner level. As previously explained, nothing in these partnership provisions requires that the character of the commission income that Brinco earned by purchasing footwear on behalf of Brown Group be separately stated and characterized at the partner level as if it had been "realized directly from the source from which realized by the partnership". Sec. 702(b). 104 T.C. 105">*124 Brown Cayman's distributive share of partnership income falls under section 702(a)(8), and the separate character of the items making up such income does not pass through to the partners under section 702(b).

Brown Group International (a U.S. corporation whose stock is wholly owned by Brown Group), Brown Cayman (a Cayman Islands corporation whose stock is wholly owned by Brown Group International), and Brinco (a Cayman Islands partnership in which Brown Cayman held an 88-percent interest) were formed in 1985 to facilitate the purchase of Brazilian footwear on behalf of Brown Group. Brinco earned commission income by acting as purchasing agent for Brown Group International.

The issue is whether Brown Cayman's distributive share of Brinco's income is "subpart F income". This question can be answered by determining whether Brown Cayman's distributive share of partnership income from Brinco is foreign base company sales income within the meaning of section 954(d)(1). ⁴

1995 U.S. Tax Ct. LEXIS 5">*40 Section 954(d)(1) provides:

SEC. 954(d). FOREIGN BASE COMPANY SALES INCOME. --

(1) IN GENERAL. --For purposes of subsection (a)(2), the term "foreign base company sales income" means income (whether in the form of profits, commissions, fees, orotherwise) derivedin connection with * * * the purchase of personal property from any person on behalf of a related person where--

(A) the property which is purchased * * * is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized, and

(B) * * * in the case of property purchased on behalf of a related person, is purchased for use, consumption, or disposition outside such foreign country.

[Emphasis added.]

JACOBS, J., dissenting: I disagree with the majority's conclusion that Brown Cayman Ltd's. (Brown Cayman's) share of partnership income from Brinco is subpart F income; therefore, I respectfully dissent.

The majority relies on three reasons to reach the holding that 1995 U.S. Tax Ct. LEXIS 5">*54 the income in question is subpart F income: (1) A technical analysis under subchapter K of the Code; (2) application of the aggregate theory of partnerships; and (3) support from the language of section 954(d)(1). Judge Chiechi, in her concurrence, explains the flaw in two of these three reasons, namely, in reasons (1) and (3). In this dissent I explain why the remaining reason, reason (2) (the application of the aggregate theory of partnerships) is flawed.

The controversy involved in this case involves a controlled foreign corporation (Brown Cayman) that was a member of a partnership (Brinco) that earned income by acting as a commission purchasing agent on behalf of the parent (Brown Group International) of the controlled foreign corporation. In reaching its conclusion, the majority would disregard Brinco as an entity and treat Brown Cayman as if it had performed the activities of Brinco. I disagree. In my opinion, the existence of Brinco should be respected, and the commission income Brinco received should be characterized at the partnership level.

"Subpart F income", as defined under section 952(a), is the sum of four specifically defined types of income. Only one type of subpart1995 U.S. Tax Ct. LEXIS 5">*55 F income, specifically "foreign base company income", is involved in this case. "Foreign base company 104 T.C. 105">*132 income", as defined under section 954(a), is the sum of five specifically defined types of income. Only one type of foreign base company income, specifically "foreign base company sales income", is involved in this case.

Section 954(d)(1) defines "foreign base company sales income" as follows:

SEC. 954(d). FOREIGN BASE COMPANY SALES INCOME. --

(1) IN GENERAL. --For purposes of subsection (a)(2), the term "foreign base company sales income" means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with the purchase of personal property from a related person and its sale to any person, the sale of personal property to any person on behalf of a related person, the purchase of personal property from any person and its sale to a related person, or the purchase of personal property from any person on behalf of a related person where--