116 T.C. No. 3



                 UNITED STATES TAX COURT



AMERICAN AIR LIQUIDE, INC. AND SUBSIDIARIES, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 20381-98.                    Filed January 16, 2001.



      P is the parent of a consolidated group that
 includes L. P’s ultimate parent is L’Air, a French
 corporation. L’Air pays royalties to P and L under
 license agreements for intellectual property owned by P
 and L and used by L’Air outside the United States.
      P treated the royalty income as sec. 904(d)(1)(I),
 I.R.C., general limitation income, relying on the
 “reserved” paragraph in sec. 1.904-5(i)(3), Income Tax
 Regs.; Article 24(3) of the U.S.-France Treaty, the
 capital nondiscrimination provision; and written
 statements of Treasury officials.
      R determined the royalty income is sec.
 904(d)(1)(A), I.R.C., passive income for the purpose of
 calculating P’s foreign tax credit.
                               - 2 -

          Held: The royalty income is passive income for the
     purpose of calculating P’s foreign tax credit. Neither
     alone nor in combination did the “reserved” paragraph
     in sec. 1.904-5(i)(3), Income Tax Regs., Article 24(3)
     of the U.S.-France Treaty, or written statements of
     Treasury officials constitute an exception to sec.
     904(d) entitling P to characterize the royalty income
     as general limitation income.

     E.A. Dominianni and Edmund S. Cohen, for petitioner.

     Steven R. Winningham, Lydia A. Branche, and Rebecca I.

Rosenberg, for respondent.

                              OPINION


     LARO, Judge:   Respondent determined deficiencies in

petitioner’s Federal income taxes of $320,351, $1,083,746, and

$942,456 for 1989, 1990, and 1991,1 respectively.

     This matter is before the Court on cross-motions for

judgment on the pleadings under Rule 120(a).2   In support of its

motion, petitioner attached exhibits to its response.   These

exhibits require us to consider matters outside the pleadings,

and as a consequence we have recharacterized the motions as

cross-motions for summary judgment under Rule 121.   See Rule

120(b).



     1
       In the petition, petitioner concedes that $160,196,
$333,746, and $222,456 of the amounts determined as deficiencies
in 1989, 1990, and 1991, respectively, are not in dispute.
     2
       Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise indicated, section references and
references to the Code are to the Internal Revenue Code in effect
for the years in issue.
                                - 3 -

       We must decide whether royalties received by petitioner, a

domestic corporation, from its foreign parent should be

classified as section 904(d)(1)(A) passive income or as section

904(d)(1)(I) general limitation income for purposes of

determining petitioner’s foreign tax credit.      We hold that they

are section 904(d)(1)(A) passive income.

                             Background

       Petitioner’s principal place of business was located in

Walnut Creek, California, when the petition was filed.      American

Air Liquide, Inc. (AAL), is the common parent of a group of

corporations that filed consolidated returns in the years in

issue.    Liquid Air Corp. (LAC) is a member of AAL’s affiliated

group.

       L’Air Liquide, S.A. (L’Air), is a French corporation that is

the ultimate parent of petitioner.      L’Air produces, sells, and

distributes industrial gases, related equipment and services, and

welding products throughout the world through its own operations

in France and through its French and non-French subsidiaries.

       In 1986, AAL acquired the LAC research facilities and rights

to all technical information developed, or being developed, by

LAC.    Under various license agreements among AAL, LAC, and L’Air,

AAL and LAC received royalties of $4,775,000, $5 million, and

$4,800,000 from L’Air in 1989, 1990, and 1991, respectively.      The

royalties were paid by L’Air for nonexclusive, irrevocable, and
                               - 4 -

perpetual licenses to exploit, outside the United States, certain

technical information developed (or to be developed) at LAC’s

research facility and certain improvements made (or to be made)

to certain patent rights licensed to LAC by L’Air.   On its tax

returns for the years in issue, petitioner characterized the

royalties received from L’Air as section 904(d)(1)(I) general

limitation income for foreign tax credit purposes.   On

examination, respondent recharacterized the royalties as section

904(d)(1)(A) passive income.   The deficiencies are a result of

this recharacterization.

                            Discussion

A.   Whether Summary Judgment Is Appropriate

      Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.   See Northern Ind. Pub.

Serv. Co. & Subs. v. Commissioner, 

, 295 (1993);

Florida Peach Corp. v. Commissioner, 

, 681 (1988);

Shiosaki v. Commissioner, 

, 862 (1974).    Summary

judgment is appropriate where there is no genuine issue as to any

material fact and a decision may be rendered as a matter of law.

See Rule 121(b); Sundstrand Corp. v. Commissioner, 

,

520 (1992), affd. 

 (7th Cir. 1994); Jacklin v.

Commissioner, 

, 344 (1982).    In deciding whether to

grant summary judgment, the Court must consider the factual

materials and inferences drawn from them in the light most
                                  - 5 -

favorable to the nonmoving party.     See Bond v. Commissioner, 

, 36 (1993); Naftel v. Commissioner, 

, 529

(1985).

     The parties agree that for the purpose of deciding these

cross-motions there are no genuine issues of material fact and

that the Court may decide the issue as a matter of law.    Hence,

this case is ripe for summary judgment.

B.   Characterization of Royalty Income

     The determination of the proper characterization of the

royalty income requires an analysis of the following provisions:

(1) Section 904, (2) section 1.904-5, Income Tax Regs., and (3)

Article 24(3) of the Convention With Respect to Taxes on Income

and Property, July 28, 1967, U.S.-Fr., T.I.A.S. 6518, as amended

by Supplementary Protocols, Oct. 12, 1970, T.I.A.S. 7270; Nov.

24, 1978, T.I.A.S. 9500; Jan. 17, 1984, T.I.A.S. 11096; and June

16, 1988, T.I.A.S. 11967 (U.S.-France Treaty).

     1.    Statutory Background

     Pursuant to section 904(a), the amount of foreign tax credit

allowable under section 901 may not exceed the same proportion of

the tax against which such credit is claimed which the taxpayer’s

taxable income from sources without the United States bears to

its entire taxable income for the same taxable year.    See sec.

904(a).   Under section 904, the allowable foreign tax credit is

computed separately for each of the categories or baskets of
                                    - 6 -

income listed in subparagraphs (A) through (I) of section

904(d)(1).3    We concern ourselves with two of these baskets.   The

first, subparagraph (I), is referred to as general limitation

income.    The other is subparagraph (A), referred to as passive

income.    In pertinent part, section 904(d)(2)(A) defines passive

income as “any income received or accrued by any person which is

of a kind which would be foreign personal holding company income


     3
          Sec. 904(d)(1) provides:

     In general. The provisions of subsections (a), (b), and
     (c) and sections 902, 907, and 960 shall be applied
     separately with respect to each of the following items
     of income:

            (A)   passive income,

            (B)   high withholding tax interest,

            (C)   financial services income,

            (D)   shipping income,

            (E)   in the case of a corporation, dividends
                  from each noncontrolled section 902
                  corporation,

            (F)   dividends from a DISC or former DISC (as
                  defined in section 992(a)) to the extent
                  such dividends are treated as income
                  from sources without the United States,

            (G)   taxable income attributed to foreign
                  trade income (within the meaning of
                  section 923(b)),

            (H)   [certain] distributions from a FSC...,
                  and

            (I)   income other than income described in
                  any of the preceding subparagraphs.
                               - 7 -

(as defined in section 954(c)).”   Subparagraph (A) of section

954(c)(1) defines “foreign personal holding company income” to

include “Dividends, interest, royalties, rents, and annuities.”

     Respondent focuses on the facts that section 904(a)(1)

places passive income into a passive basket and that “royalties”

are specifically referred to in section 954(c)(1) as a type of

passive income.   Petitioner expands on this focus by reference to

section 904(d)(3)(C) and section 1.904-5, Income Tax Regs., which

together apply a look-through rule in the case of controlled

foreign corporations and other entities.   Section 904(d)(3)(C)

provides:

     Any interest, rent, or royalty which is received or accrued
     from a controlled foreign corporation in which the taxpayer
     is a United States shareholder shall be treated as income in
     a separate category to the extent it is allocable (under
     regulations prescribed by the Secretary) to income of the
     controlled foreign corporation.

Section 1.904-5(b), Income Tax Regs., provides:

     In general. Except as otherwise provided in section
     904(d)(3) and this section, dividends, interest, rents,
     and royalties received or accrued by a taxpayer from a
     controlled foreign corporation in which the taxpayer is
     a United States shareholder shall be treated as general
     limitation income.

Section 1.904-5(i)(3), Income Tax Regs., is also relevant to

petitioner’s analysis.   It is entitled “Special rule for payments

from foreign parents to domestic subsidiaries” and contains no

text.   The Secretary explicitly “[RESERVED]” the rules under that

provision during the years in issue.   In 1992 the Secretary
                               - 8 -

promulgated new final regulations which omitted the reserved

paragraph.   The preamble to the new final regulations states that

the Commissioner had decided not to adopt rules which look

through payments from foreign parents to U.S. subsidiaries

because of administrative and policy concerns.   The preamble

states:

     To apply the look-through rules, the Service needs
     complete information concerning the foreign
     corporation’s income and expenses. The Service may not
     be able to obtain all of the necessary information from
     a foreign parent corporation and to audit it. In
     addition, the payments generally would be deductible
     from taxable income of the payor that is entirely
     outside the jurisdiction of the United States
     (including subpart F) and, therefore, do not give rise
     to the same concerns involved in other look-through
     cases. [T.D. 8412, 1992-1 C.B. 273 (preamble to the
     1992 final regulations).]

     Petitioner further relies on the U.S.-France Treaty and more

specifically the nondiscrimination provision embodied in Article

24(3), which provides:

     A corporation of a Contracting State, the capital of
     which is wholly or partly owned or controlled, directly
     or indirectly, by one or more residents of the other
     Contracting State, shall not be subjected in the first-
     mentioned Contracting State to any taxation or any
     requirement connected therewith which is other or more
     burdensome than the taxation and connected requirements
     to which a corporation of that first-mentioned
     Contracting State carrying on the same activities, the
     capital of which is wholly owned by one or more
     residents of that first-mentioned State, is or may be
     subjected.

     Unless there is a reason to disregard the general rule of

section 904(d), petitioner’s royalties from L’Air should be
                                - 9 -

characterized as passive income for the purpose of computing

petitioner’s foreign tax credit limitation.

     2.   Petitioner’s Position That Royalties Received Are
          General Limitation Income

     Petitioner makes three arguments in support of its position

that the royalties received should not be treated as passive

income.   Firstly, petitioner argues, treating royalties received

from L’Air as passive basket income impermissibly discriminates

against petitioner in violation of the nondiscrimination article

of the U.S.-France Treaty.   Secondly, petitioner argues, the

“reserved” paragraph in section 1.904-5(i)(3) Income Tax Regs.,

when read in the relevant regulatory context and in light of

public written statements, mandates that royalties such as those

at issue be categorized as general limitation income.   Thirdly,

petitioner argues, senior Treasury officials have stated clearly

in writing that the Department of the Treasury will shortly issue

regulations under which the subject royalties are categorized as

general limitation income.   To date, no such retroactive

regulations have been issued.   However, on January 3, 2001, the

Department of the Treasury published proposed rules that, among

other things, “propose to amend prospectively § 1.904-4(b)(2)”,

Income Tax Regs.   66 Fed. Reg. 319, 320 (emphasis added).    The

supplementary information accompanying the proposed regulation

states:

     Treasury and the IRS have consistently declined to extend
                                - 10 -

     look-through treatment to payments from foreign non-
     controlled payors. See TD 8412 (1992-1 C.B. 271, 273).
     Treasury and the IRS continue to believe that the nature of
     the income earned by a foreign non-controlled payor from the
     use of the licensed property should not determine whether a
     rent or royalty payment constitutes income from the active
     conduct of a trade or business of the recipient. [Id.]

The supplementary information accompanying the proposed

regulation strongly supports respondent’s position in the instant

case.     Further, we find no support for petitioner’s arguments

contained in the proposed regulations.

C.   Analysis

     1.      Interaction of Code and U.S.-France Treaty Provision

     Under the U.S. Constitution, treaties are given equal status

with laws passed by Congress.     See U.S. Const., art. VI, sec. 1,

cl. 2.     A treaty is to be liberally construed to give effect to

the purpose which animates it.     See United States v. Stuart, 

, 368 (1989); Bacardi Corp. of Am. v. Domenech, 

, 163 (1940).     When a provision of a treaty fairly admits of

two constructions, one restricting, the other enlarging, rights

which may be claimed under it, the more liberal interpretation is

to be preferred.     See United States v. Stuart, supra at 368;

Bacardi Corp. of Am. v. Domenech, supra; Samann v. Commissioner,

, 1014-1015 (1961), affd. 

 (4th Cir.

1963).     In construing a treaty, the Court gives the language its

ordinary meaning in the context of the treaty, unless a more

restricted sense is clearly intended.     See De Geofroy v. Riggs,
                              - 11 -

, 271 (1890).   When a treaty and a statute relate to

the same subject, courts attempt to construe them so as to give

effect to both, see Whitney v. Robertson, 

, 194

(1888), because “the intention to abrogate or modify a treaty is

not to be lightly imputed to the Congress”, Menominee Tribe v.

United States, 

, 413 (1968) (quoting Pigeon River Co.

v. Cox Co., 

, 160 (1934)); see also Estate of

Burghardt v. Commissioner, 

, 713 (1983), affd. without

published opinion 

 (3d Cir. 1984).

     Petitioner argues that the characterization of royalty

income under section 904 must be identical for royalties received

by a U.S. subsidiary from a foreign parent corporation and

royalties received by a domestic corporation from a controlled

foreign corporation.   Petitioner argues that to not characterize

its royalty income from L’Air as section 904(d)(1)(I) general

limitation income would violate Article 24(3) of the U.S.-France

Treaty.   Petitioner cites the deficiency itself as evidence of

the detriment it suffers because respondent treats the royalty

income as passive income rather than general limitation income.

We disagree with petitioner’s analysis.   Petitioner’s analysis

ignores the differences in the tax treatment, imposed by subpart

F, sections 951 to 964, of the Code, and consequently the

circumstances of the respective taxpayers mentioned.

     Article 24(3), which corresponds to Article 24(5) of the
                               - 12 -

current OECD model convention, is a means “to ensure equal

treatment for taxpayers residing in the same State.”    I Model Tax

Convention On Income and On Capital, Article 24, par. 5, 57 (OECD

Nov. 1977).    Petitioner is a domestic corporation, and the tax

treatment of its foreign source royalty income is determined in

exactly the same manner as for any other domestic corporation

receiving royalty income from a noncontrolled foreign

corporation.   Petitioner has received equal treatment with all

other similarly situated taxpayers residing in the United States.

The fact that petitioner’s ultimate parent is a French

corporation plays no part in determining the characterization of

petitioner’s royalty income.    Consequently, we do not find any

basis for petitioner’s assertion that respondent’s alleged

failure to characterize petitioner’s royalty income as section

904(d)(1)(I) general limitation income contravenes Article 24(3)

of the U.S.-France Treaty.

     2.   The “Reserved” Paragraph and Treasury Representations

     For convenience, we will examine petitioner’s second and

third arguments together.    Petitioner’s reliance on the

“reserved” paragraph in section 1.904-5(i)(3), Income Tax Regs.,

is also misplaced.    In Connecticut Gen. Life Ins. Co. v.

Commissioner, 

, 110 (1997), affd. 

 (3d

Cir. 1999), we held in similar circumstances that a reserved

paragraph in a regulation “simply reserves a space for
                              - 13 -

regulations that may be promulgated at a later date and that may

provide a special rule”.   (Emphasis added).   The Court of Appeals

for the Third Circuit when discussing the same reserved provision

stated:

     the Office of the Federal Register, Document Drafting
     Handbook (1991), * * * describes “reserved” as “a term
     used to maintain the continuity of codification in the
     CFR” or “to indicate where future text will be added.”
     Id. at 27. We find nothing in the precedent that * *
     *[the taxpayer] cites to preclude the Commissioner from
     using the term “reserved” in accordance with the
     Document Drafting Handbook, rather than to connote the
     absence of a substantive rule. [Connecticut Gen. Life
     Ins. Co. v. Commissioner, 177 F.3d at 145.]

We see no reason to take a different view in this case.   The

reserved paragraph as a general rule only indicates a place mark

in the regulation that is reserved to preserve continuity of

codification where the Department of the Treasury is considering

its position.

     Petitioner, in its memorandum of law in support, seeks to

distinguish Connecticut Gen. Life Ins. Co. v. Commissioner,

supra, on the basis that unlike the facts in that case, in the

instant case, “the meaning ascribed to the Reserved Paragraph by

the Petitioner is unambiguously supported by numerous public

written statements of similarly affected taxpayers, and is not

contradicted in any of numerous public statements made by senior

Treasury Department and other governmental officials addressing

the issue”.   Petitioner attached to its response to respondent’s

motion for judgment on the pleadings exhibits A through H.    These
                             - 14 -

exhibits contain correspondence on the Department of the Treasury

letterhead, and correspondence to the Department of the Treasury.

Taken together, and viewed in the light most favorable to

petitioner, we are unable to conclude that they represent

anything more than confirmation that the Department of the

Treasury was considering whether to extend look-through treatment

to domestic subsidiaries with foreign parents.

     Accordingly,

                                   An appropriate order will be

                              entered granting respondent’s

                              motion for summary judgment and

                              denying petitioner’s motion for

                              summary judgment.   Decision will be

                              entered for respondent.