3. Application of Regulations by the Parties

Petitioners contend that subdivision (i) of the regulation requires the computation of CTI in accordance with the method they use to account for domestic taxable income. Section 1.451-3(d) (5) (iii), Income Tax Regs., permits a variation from the completed contract method for electing taxpayers to currently deduct period costs even though the related income is not reportable until a later taxable year when the contract is completed. Due to their election to currently deduct period costs, petitioners argue that, in the year of contract completion, they should not be required to reduce foreign gross receipts by period costs that were deducted in computing prior years' income taxes. Because 1997 U.S. Tax Ct. LEXIS 8">*31 they cannot deduct prior year period costs in the years in issue, petitioners contend that those period costs need not be utilized in computing CTI.

Conversely, respondent argues that, in accord with the congressional intent as reflected in the legislative history, the regulations require a taxpayer to account for all costs that relate to export sales, including period costs deducted in prior years. Respondent further argues that petitioners' accounting method and any permissible variations therefrom do not control in determining the statutory limitations for computing CTI. We agree with respondent.

C. Whether Section 1.994-1(c)(6), Income Tax Regs., Is a Reasonable Interpretation of the Statute

The regulation in controversy was intended to define the statutory phrase "combined taxable income". That phrase is not defined in the Internal Revenue Code. The regulation promulgated by the Secretary is couched in broad terms, leaving room for the parties to advance differing interpretations. In this regard, petitioners have not questioned the validity of the regulation under consideration. The regulatory formula for CTI is the "excess of the gross receipts * * * over the total costs * * 1997 U.S. Tax Ct. LEXIS 8">*32 * which relate to such gross receipts." Sec. 108 T.C. 107">*120 1.994-1(c)(6), Income Tax Regs. The regulation also provides that the taxpayer may in certain circumstances use the same method of accounting in computing CTI as used during the taxable year for which CTI is being computed. Sec. 1.994-1(c)(6)(i), Income Tax Regs.

The term "total costs" is ambiguous and does not delineate whether the "total" is for the year, as petitioners contend, or all costs relating to the gross receipts, including those incurred and deducted in a prior year. Accordingly, petitioners and respondent are both placed in the position of advancing, for purposes of this litigation, their respective interpretations of the language of the regulation.

Normally, we defer to regulations which "implement the congressional mandate in some reasonable manner." United States v. Vogel Fertilizer Co., 455 U.S. 16">455 U.S. 16, 455 U.S. 16">24 (1982) (quoting United States v. Correll, 389 U.S. 299">389 U.S. 299, 389 U.S. 299">307 (1967)); Rowan Cos., Inc. v. United States, 452 U.S. 247">452 U.S. 247, 452 U.S. 247">252 (1981); National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472">440 U.S. 472, 440 U.S. 472">476 (1979). ^{71997 U.S. Tax Ct. LEXIS 8">*34} Respondent's litigating position is not afforded any more deference than that of petitioners. By way of 1997 U.S. Tax Ct. LEXIS 8">*33 example, proposed regulations and revenue rulings are generally not afforded any more weight than that of a position advanced by the Commissioner on brief. Laglia v. Commissioner, 88 T.C. 894">88 T.C. 894, 88 T.C. 894">897 (1987); Estate of Lang v. Commissioner, 64 T.C. 404">64 T.C. 404, 64 T.C. 404">407 (1975), affd. in part and revd. in part 613 F.2d 770">613 F.2d 770 (9th Cir. 1980). That is especially so here, where respondent did not publish her position prior 108 T.C. 107">*121 to this controversy. Accordingly, we proceed to decide which party's approach harmonizes with the statutory intent.

Section 994(a)(2) presents the somewhat ambiguous and completely undefined term "combined taxable income." The regulation in question does not conflict with the language of the statute it interprets. In addition, the regulatory definition of costs related to export sales is consistent with legislative history, which 1997 U.S. Tax Ct. LEXIS 8">*35 states:

the combined taxable income * * * would be determined by deducting from the DISC's gross receipts the related person's cost of goods sold with respect to the property, the selling, overhead and administrative expenses of both the DISC and the related person which are directly related to the production or sale of the export property and a portion of the related person's and the DISC's expenses not allocable to any specific item of income, such portion to be determined on the basis of the ratio of the combined gross income from the export property to the total gross income of the related person and the DISC. [Fn. ref. omitted; emphasis added.]

D. Interpretation of the Regulatory Definition of "Combined Taxable Income"

Regulations that are valid exercises of the powers of the Secretary 1997 U.S. Tax Ct. LEXIS 8">*36 have the force and effect of law. Sim-Air, USA, Ltd. v. Commissioner, 98 T.C. 187">98 T.C. 187, 98 T.C. 187">198 (1992). The rules for interpreting a valid regulation are similar to those governing the interpretation of statutes. KCMC, Inc. v. FCC, 600 F.2d 546">600 F.2d 546, 600 F.2d 546">549 (5th Cir. 1979); Intel Corp. & Consol. Subs. v. Commissioner, 100 T.C. 616">100 T.C. 616, 100 T.C. 616">631 (1993), affd. 67 F.3d 1445">67 F.3d 1445 (9th Cir. 1995). When construing a statute, or in this case a regulation, we are to give effect to its plain and ordinary meaning unless to do so would produce absurd results. Green v. Bock Laundry Mach. Co., 490 U.S. 504">490 U.S. 504, 490 U.S. 504">509 (1989); Exxon Corp. v. Commissioner, 102 T.C. 721">102 T.C. 721 (1994). The most basic tenet of statutory construction is to begin with the language of the statute itself. United States v. Ron Pair Enters., Inc., 108 T.C. 107">*122 489 U.S. 235">489 U.S. 235, 489 U.S. 235">241 (1989). When the plain language of the statute is clear and unambiguous, that is where the inquiry should end. Id. Where a statute is silent or ambiguous, we look to legislative history to ascertain congressional intent. Peterson Marital Trust v. Commissioner, 102 T.C. 790">102 T.C. 790, 102 T.C. 790">799 (1994), affd. 78 F.3d 795">78 F.3d 795 (2d Cir. 1996). We apply these rules to interpret the regulations promulgated under section 994. 1997 U.S. Tax Ct. LEXIS 8">*37

An integral part of calculating CTI is determining the costs of the export sales. Sec. 1.994-1(c)(6), Income Tax Regs.The regulations under section 994 require taxpayers to account for the "total costs" related to export sales. Sec. 1.994-1(c)(6), Income Tax Regs.; see sec. 1.925(a)-1T(c)(6)(ii), Temporary Income Tax Regs., 52 Fed. Reg. 6446 (Mar. 3, 1987). Total costs include costs that definitely relate to the export sales and a ratable share of costs that do not definitely relate to any class of gross income. Sec. 1.994-1(c)(6)(iii), Income Tax Regs.; see sec. 1.925(a)-1T(c)(iii)(D), Temporary Income Tax Regs., supra. Thus, taxpayers must allocate their costs between export sales and domestic sales to compute CTI. Sec. 1.994-1(c)(6)(iii), Income Tax Regs.; see sec. 1.925(a)-1T(c)(6)(iii)(D), Temporary Income Tax Regs., supra.

Rather than creating a new method of cost allocation within the DISC provisions, Congress intended that taxpayers use the method for allocating costs under section 1.861-8, Income Tax Regs.The intended method for allocating expenses in the CTI computations appears consistent throughout the legislative history of the DISC provisions, which states:

the 1997 U.S. Tax Ct. LEXIS 8">*38 combined taxable income from the sale of the export property is to be determined generally in accordance with the principles applicable under section 861 for determining the source (within or without the United States) of the income of a single entity with operations in more than one country. These rules generally allocate to each item of gross income all expenses directly related thereto, and then apportion other expenses among all items of gross income on a ratable basis. * * * [Emphasis added.]

In general, section 1.861-8, Income Tax Regs., provides geographic sourcing rules to allocate and apportion expenses between the United States and foreign countries. It also provides rules for determining taxable income from specific activities and for allocating 1997 U.S. Tax Ct. LEXIS 8">*39 income and deductions to those activities under other sections of the Code referred to as "operative sections". Sec. 1.861-8(a)(1), (f)(1)(i)-(vi), Income Tax Regs. Operative sections define the categories of income between which taxpayers must allocate their deductions and gross income.

Section 994 is an operative section wherein income is grouped into two categories; i.e., income from export sales, referred to as the statutory grouping, and all remaining gross income, referred to as the residual grouping. St. Jude Medical, Inc. v. Commissioner, 97 T.C. 457">97 T.C. 457, 97 T.C. 457">465 (1991), affd. in part and revd. in part and remanded 34 F.3d 1394">34 F.3d 1394 (8th Cir. 1994); sec. 1.861-8(f)(1)(iii), Income Tax Regs. Under section 1.861-8, Income Tax Regs., taxpayers must allocate their deductions to a class of gross income and, then, if necessary to make the determination required by the operative section, apportion the deductions within the class of gross income between the statutory and residual groupings. Sec. 1.861-8(a)(2), Income Tax Regs. The apportionment must be accomplished in a manner that reflects to a "reasonably close extent" the factual relationship between the deduction and the income grouping. 1997 U.S. Tax Ct. LEXIS 8">*40 Sec. 1.861-8(c)(1), Income Tax Regs.

Similar to the related costs definition in section 1.994-1(c)(6)(iii), Income Tax Regs., section 1.861-8, Income Tax Regs., requires allocation of deductions to definitely related classes of gross income. Any deductions that do not definitely relate to a class of gross income are ratably apportioned to all gross income based on the ratio of gross income from each class to the taxpayer's total gross income. Sec. 1.861-8(a)(2), (b)(1), and (c)(3), Income Tax Regs. A cost is "definitely related" to a class of gross income if it is incurred as a result of, or incident to, an activity or in connection with property from which that class of gross income is derived. Sec. 1.861-8(b)(2), Income Tax Regs. In general, period costs benefit and relate to the taxpayer's business as a whole and are not incident to or necessary for the performance of a particular 108 T.C. 107">*124 contract. McMaster v. Commissioner, 69 T.C. 952">69 T.C. 952, 69 T.C. 952">955 (1978). Thus, period costs are costs that do not definitely relate to any class of gross income, as defined by sections 1.994-1(c)(6)(iii) and 1.861-8, Income Tax Regs., and must be ratably apportioned to all gross income.

Additionally, section 1.861-8, Income Tax Regs., 1997 U.S. Tax Ct. LEXIS 8">*41 does not distinguish period costs from other costs that relate to export sales. Furthermore, section 1.861-8, Income Tax Regs., does not excuse taxpayers from allocating costs to a class of gross income unless the costs are definitely related to another class of gross income. Section 1.861-8(a)(2), Income Tax Regs., provides: "Except for deductions, if any, which are not definitely related to gross income * * * and which, therefore, are ratably apportioned to all gross income, all deductions of the taxpayer * * * must be so allocated and apportioned." Thus, consistent with the section 994 regulations, section 1.861-8, Income Tax Regs., requires taxpayers to prove that the prior year period costs definitely relate to gross income from a source other than export sales, which petitioners have failed to do, to avoid having to account for those costs in determining CTI.

The regulations under section 994, which incorporate section 1.861-8, Income Tax Regs., are consistent with the statutory intent and legislative history. By requiring taxpayers to account for all costs incurred to produce export property in calculating CTI, the regulations limit the deferral or exclusion of income to the 1997 U.S. Tax Ct. LEXIS 8">*42 actual income from foreign sales after considering "total costs". In addition, the regulations do not permit the exclusion of any particular costs, such as prior year period costs, from the computation of CTI, unless the costs definitely relate to a class of gross income other than export sales. Sec. 1.994-1(c)(6), Income Tax Regs.; sec. 1.925(a)-1T(c)(6)(iii), Temporary Income Tax Regs., supra.

Implicit in petitioners' position that they are following the completed contract method is that the total costs are only those claimed in the computation year. Petitioners do not provide us with a logical or reasonable definition of "total costs" and/or "related costs" that would harmonize with the statutory limitation intended by Congress. Nor have petitioners shown that the prior year period costs definitely relate to a class of gross income other than export sales. It has not been argued that the prior year period costs are unrelated to 108 T.C. 107">*125 petitioners' export sales. In addition, petitioners previously allocated the prior year period costs to particular export sales contracts as they accrued. Thus, we find that the regulatory definition of related costs includes prior year period costs that 1997 U.S. Tax Ct. LEXIS 8">*43 have previously been deducted. Petitioners must account for both current and prior year period costs in determining their CTI.

E. The Effect of the Taxpayer's Method of Accounting on the Computation of Combined Taxable Income

Petitioners also argue that they are properly applying their method of accounting by not reducing CTI by prior year period costs. Rather than suggesting an alternative definition of total costs that excludes prior year period costs, petitioners rely on subdivision (i) of section 1.994-1(c)(6), Income Tax Regs. That subdivision permits taxpayers to use their normal method of accounting in computing CTI. Petitioners interpret that regulation to require taxpayers to compute CTI in accordance with their method of accounting. Accordingly, petitioners contend that whether costs related to export sales, as defined in section 1.994-1(c)(6)(iii), Income Tax Regs., are allocable to those export sales for purposes of determining CTI depends on their accounting method.

Section 1.994-1(c)(6)(i), Income Tax Regs., provides:

(i) Subject to subdivisions (ii) through (v) of this subparagraph, the taxpayer's method of accounting used in computing taxable income will be accepted 1997 U.S. Tax Ct. LEXIS 8">*44 for purposes of determining amounts and the taxable year for which items of income and expense (including depreciation) are taken into account. * * *

In addition to their misplaced reliance on subdivision (i) of section 1.994-1(c)(6), Income Tax Regs., petitioners also assert that section 1.861-8, Income Tax Regs., supports their 108 T.C. 107">*126 position that they are not required to account for prior year period costs. As stated above, Congress intended taxpayers exporting through DISC's to allocate their income and costs to export sales pursuant to the requirements of section 1.861-8, Income Tax Regs. Rather than address the substantive allocation requirements of section 1.861-8, Income Tax Regs., 1997 U.S. Tax Ct. LEXIS 8">*45 as described above, petitioners again concentrate their argument on their accounting method. Petitioners argue that section 1.861-8, Income Tax Regs., requires that the principles of annual accounting apply to income and cost allocations. Petitioners deducted the period costs in prior years in accordance with the completed contract method. Therefore, petitioners contend that requiring them to account for the prior year period costs in the year of contract completion to compute CTI is inconsistent with the principles of annual accounting.

Under the principles of annual accounting, a transaction must be accounted for under the taxpayer's method of accounting on the basis of the facts in the year the transaction occurs. Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281 (1944); Burnet v. Sanford & Brooks Co., 282 U.S. 359">282 U.S. 359 (1931); Landreth v. Commissioner, 859 F.2d 643">859 F.2d 643 (9th Cir. 1988), affg. in part, revg. in part, and remanding T.C. Memo. 1985-413. Section 461(a) requires that a deduction be taken in the taxable year that is proper under the taxpayer's method of accounting.

The completed contract method requires income and deductions from long-term contracts to be reported in the 1997 U.S. Tax Ct. LEXIS 8">*46 year in which the contracts are completed. Sec. 1.451-3(d)(1), Income Tax Regs. However, section 1.451-3(d)(5)(iii), Income Tax Regs., provides a variation or exception to the requirement that deductions be deferred. A current deduction is allowed, at the taxpayer's election, for period costs. Texas Instruments Inc. v. Commissioner, T.C. Memo. 1992-306; sec. 1.451-3(d)(5)(iii), Income Tax Regs. Period costs include marketing and selling expenses, distribution expenses, general and administrative expenses attributable to the performance of services that benefit the taxpayer's activities as a whole, casualty losses, certain pension and profit-sharing contributions, and costs attributable to strikes, rework labor, scrap, and spoilage. Sec. 1.451-3(d)(5)(iii), Income Tax Regs.

108 T.C. 107">*127 Petitioners' use of the completed contract method of accounting to report income and deductions for their long-term contracts has not been questioned. This method of accounting provides an alternative to the annual accrual method of accounting for long-term contracts for which the ultimate profit or loss is not ascertainable until the contract is completed. See RECO Indus., Inc. v. Commissioner, 83 T.C. 912">83 T.C. 912, 83 T.C. 912">921 (1984). 1997 U.S. Tax Ct. LEXIS 8">*47 The method allows a taxpayer to account for the entire result of a long-term contract at one time. Id. The purpose of the completed contract method is to match the costs of generating income with the income produced. In this case, however, petitioners try to use the completed contract method to avoid the matching of costs with income from export sales for purposes of computing CTI as required by the regulations under sections 994 and 925. As a result, petitioners did not subtract all the costs related to their export sales as defined in section 1.994-1(c)(6)(iii), Income Tax Regs., from the export income that the expenditures generated.

The completed contract method of accounting does not necessarily conflict with requiring taxpayers to account for all related period costs in determining CTI. The completed contract method is an accounting method that allocates to a particular taxable year the items of income and expenses that must be reported within that year. It is relevant only to the timing of deductions and income recognition. 83 T.C. 912">RECO Indus., Inc. v. Commissioner, supra at 922. Like other accounting methods, the completed contract method relies on other sections of the Code, such 1997 U.S. Tax Ct. LEXIS 8">*48 as the DISC provisions, to determine the amount of income to be recognized and the amount of allowable deductions. The purpose of the pricing rules in the DISC provisions is to determine the amount of income that taxpayers engaged in export activities must recognize and the amount of income that is tax deferred. The completed contract method has a different purpose. It determines the taxable year in which a related supplier recognizes the income attributable to export sales, the amount of income to be recognized having been determined by the DISC provisions. Thus, the variations or exceptions to the completed contract method here do not govern which costs are allocable to long-term export contracts for purposes of determining CTI.

108 T.C. 107">*128 In addition, requiring taxpayers to account for prior year period costs in calculating CTI does not interfere with the current deduction allowed for period costs under the completed contract method. Petitioners' interpretation of the completed contract method gives taxpayers benefits in addition to their ability to currently deduct period costs. There is no indication that Congress intended the limitation on deferral or exclusion to promote foreign exports 1997 U.S. Tax Ct. LEXIS 8">*49 to include a double or extra benefit only for those taxpayers on the completed contract method who elected to deduct period costs on an annual basis.

Accepting petitioners' argument would mean that taxpayers using the completed contract method of accounting would calculate their CTI in accordance with section 1.451-3, Income Tax Regs., as opposed to the regulations under sections 994 and 925. Under section 1.861-8, Income Tax Regs., the costs to be allocated are defined by the operative section which references that regulation. Thus, we look to sections 994 and 925 and the related regulations to determine which costs are allocable to export sales for purposes of determining CTI, not the regulations under section 451 as petitioners contend. Although period costs are not required to be allocated to long-term contracts for cost-deferral purposes under section 1.451-3(d)(5)(iii), Income Tax Regs., sections 994(a) and 925(a) and the related regulations require that all costs, including prior year period costs, be accounted for in determining CTI.

Requiring petitioners to account for all period costs in determining CTI is consistent with the completed contract method of accounting. Allowing 1997 U.S. Tax Ct. LEXIS 8">*50 taxpayers to use their normal method of accounting to compute CTI does not necessarily cede to the accounting methodology the computation of the limitation of the benefit to be generated by foreign exports. Petitioners must account for all related costs, including period costs, of both current and prior years in determining their CTI from export sales.

II. Regulatory Definition of "Export Property"

Petitioners manufactured two specialized vessels that were designed and built for transoceanic transport of liquefied natural gas. The tankers were manufactured under contract 108 T.C. 107">*129 for sale to a company for direct use outside the United States. After the completion, but before the tankers could be used for foreign purposes, unforeseen delays caused some domestic use of one of the tankers. The delay also caused both tankers not to be used in foreign commerce prior to 1 year after their sale.

In order for petitioners' DISC to retain its statutory status, 95 percent of its gross receipts must consist of qualified export receipts. Sec. 993(e). Qualified export receipts include gross receipts from the sale, exchange, or other disposition of export property. "Export property" is statutorily defined, 1997 U.S. Tax Ct. LEXIS 8">*51 in pertinent part, as "property * * * manufactured * * * in the United States by a person other than a DISC, * * * held primarily for sale, * * * in the ordinary course of trade or business * * * for direct use, consumption, or disposition outside the United States". Sec. 993(c)(1).

The regulations in connection with the definition of "export property" provide for a "destination test". Property satisfies the destination test "only if it is * * * directly used * * * outside the United States * * * by the purchaser * * * within 1 year after such sale". Sec. 1.993-3(d)(2)(i)(b), Income Tax Regs. Petitioners contend that the destination test of the regulation is not a proper interpretation of the statutory provision and hence is invalid.

We have already addressed the destination test and found valid section 1.993-3(d)(2)(i)(b), Income Tax Regs., in Sim-Air, USA, Ltd. v. Commissioner, 98 T.C. 187">98 T.C. 187, 98 T.C. 187">190-197 (1992). There is nothing in petitioners' argument here that would warrant a change in our reasoning or conclusion concerning the validity of that aspect of the DISC regulations. Petitioners also raise factual distinctions between this case and Sim-Air. Factual differences between cases, 1997 U.S. Tax Ct. LEXIS 8">*52 however, do not address the question of whether a particular regulation is a proper interpretation of a statutory provision.

Petitioners also argue that they should be relieved of the 1-year destination requirement because of the unforeseen factual circumstances that caused them not to meet the regulation's requirement. The taxpayer in Sim-Air made a similar argument that was rejected. 98 T.C. 187">Id. at 197-198. Once a regulation is found valid, it has the force and effect of law. That law (both the statute and the regulation in question here) does not provide any exception for reasonable delay or 108 T.C. 107">*130 unforeseen events. Nor is there room to interpret the statute or regulation to permit petitioners' factual circumstances different treatment by means of a waiver or exemption from the requirement under consideration.

Petitioners also question the validity of other subparts of the export property regulation, but we find it unnecessary to consider that and other positions of the parties because petitioners' failure to satisfy the 1-year test is dispositive of this issue.

To reflect the foregoing,

An appropriate order will be issued reflecting the resolution of the foreign issues in controversy.