UNITED STATES TAX COURT



  SUNOCO, INC. AND SUBSIDIARIES, Petitioner v.
  COMMISSIONER OF INTERNAL REVENUE, Respondent


Docket No. 19631-97.          Filed March 15, 2002.


     P claimed foreign tax credits under sec.
901(a), I.R.C., on its consolidated returns
for 1982, 1983, 1984, and 1986. In these
proceedings, P seeks to change the method of
computing the overall limitation on the credit
imposed by sec. 904(a), I.R.C. Specifically, P
seeks to change the manner in which it allocates
and apportions interest expenses for purposes
of computing taxable income from sources without
the United States, the numerator of the limiting
fraction. P claims that it is entitled to offset
interest income against interest expenses before
it allocates and apportions net interest expenses
under sec. 1.861-8(e)(2), Income Tax Regs.
     Held: Sec. 1.861-8(e)(2), Income Tax Regs.,
does not permit P to allocate and apportion net
interest expenses. The Tax Court's decision in
Bowater, Inc., & Subs. v. Commissioner, 

(1993), revd. 

(2d Cir. 1997),
which holds the opposite, is hereby overruled.
                               - 2 -

     Marjorie A. Burnett, Thomas D. Johnston, Robert L.

Moore II, Michael J. McGoldrick, and Nancy M. Seweryn,

for petitioner.

     John A. Guarnieri, Richard H. Gannon, and Keith L.

Gorman, for respondent.


                              OPINION

     WHALEN, Judge:      Respondent determined the following

deficiencies in petitioner's Federal income tax:

                  Year             Deficiency

                  1979            $10,563,157
                  1981              5,163,449
                  1983             35,916,359


Petitioner disputes the above deficiencies and further

claims to have overpaid income taxes for 1979, 1981, and

1983 by at least $25,082,591, $6,881,055, and $14,137,211,

respectively.

     After concessions, there are three issues for decision

in this case.     Each issue will be the subject of a separate

opinion.   The issue that is the subject of this opinion

arises in the context of computing the overall limit

imposed by section 904(a) on the foreign tax credits

claimed by petitioner under section 901(a) for taxable

years 1982, 1983, 1984, and 1986, referred to herein as

the years in issue.      In this opinion, all section
                             -3-

references are to the Internal Revenue Code as in effect

during the years in issue, unless stated otherwise.

     This issue involves the computation of income from

sources without the United States, the numerator of the

limiting fraction under section 904(a).    Specifically,

in allocating and apportioning interest expenses for

purposes of computing taxable income from sources without

the United States for the years in issue, the question is

whether section 1.861-8(e)(2), Income Tax Regs.,

contemplates that the aggregate interest expense

incurred by each member of petitioner's affiliated group

of corporations for the taxable year can first be offset

by that member's interest income.    Stated more simply, the

issue is whether netting of interest expense and interest

income is permitted by section 1.861-8(e)(2), Income Tax

Regs.

     As a preliminary matter, we must decide an evidentiary

objection raised by respondent.    Respondent filed a motion

in limine to exclude the testimony of an economist, Dr. J.

Gregory Ballentine, who was called by petitioner as an

expert witness.   Respondent argues that Dr. Ballentine's

testimony should be excluded because it represents

"irrelevant and immaterial legal conclusions and opinions

and does not assist the Court."    Respondent also contends
                            - 4 -

that Dr. Ballentine's testimony should be excluded because

it amounts to impermissible advocacy.

     Respondent also proffered the testimony of an expert

witness but did so only to preserve the Commissioner's

right to offer such testimony if the testimony of

petitioner's expert were admitted into evidence.    At trial,

the Court permitted both experts to testify and reserved

ruling on respondent's motion in limine.

     Petitioner offers the testimony of Dr. Ballentine to

"assist the Court in interpreting the economic terms in

section 1.861-8(e)(2)", Income Tax Regs.    According to his

report, Dr. Ballentine reached two overall conclusions:

(1) "Netting interest income against interest expense

implements the economic concept of the fungibility of money

as it relates to sources of funds"; (2) "interest netting

achieves a tax neutrality between borrowing and reducing

cash balances as sources of funds."    Petitioner argues

the same two principles in the posttrial briefs filed on

its behalf.   Dr. Ballentine's report states that he was

retained "to provide an economic evaluation of netting

interest income against interest expense for purposes of

the tax rules that apportion interest expense between

domestic and foreign source income."
                              - 5 -

     Rule 702 of the Federal Rules of Evidence, which

governs the admissibility of expert testimony, provides:


          If scientific, technical, or other
     specialized knowledge will assist the trier of
     fact to understand the evidence or to determine
     a fact in issue, a witness qualified as an
     expert by knowledge, skill, experience, train-
     ing, or education, may testify thereto in the
     form of an opinion or otherwise.* * *


Thus, expert testimony is admissible under rule 702 if

it assists the Court to understand the evidence or to

determine a fact in issue.

     The parties agree that the subject issue, involving

the interpretation of section 1.861-8(e)(2), Income Tax

Regs., is a question of law and that there are no facts

in dispute.   Thus, the question we must answer is whether

Dr. Ballentine's testimony aids the Court in understanding

the evidence.   Dr. Ballentine's testimony provides economic

examples and policy reasons as to why the appropriate

measure of interest expense is net interest expense.

Petitioner's brief reiterates these same concepts and

includes the same examples.

     We find that Dr. Ballentine's report and testimony

merely advocate petitioner's position and do not aid the

Court "to understand the evidence or to determine a fact
                              - 6 -

in issue".   Fed. R. Evid. 702.    Expert testimony is not

admissible for such purposes.     An expert who is merely an

advocate of a party's position does not assist the Court

in understanding the issue.    See Hosp. Corp. of Am.

v. Commissioner, 

(1997); Alumax, Inc. v.

Commissioner, 

(1997), affd. 

(11th Cir. 1999); Snap-Drape, Inc. v. Commissioner, 

, 20 (1995), affd. 

(5th Cir. 1996);

Laureys v. Commissioner, 

, 129 (1989);

Robertson v. Commissioner, T.C. Memo. 1999-130, affd.

without published opinion 87 AFTR2d 2001-1274, 2001-1 USTC

par. 50,276 (9th Cir. 2001); see also Estate of Halas v.

Commissioner, 

, 577 (1990) ("In the context of

valuation cases, we have observed that experts may lose

their usefulness and credibility when they merely become

advocates for one side.").

     We conclude that Dr. Ballentine's testimony does

not assist the Court in understanding the legal question

issue and is not admissible.    Accordingly, we shall grant

respondent's motion in limine.

     Most of the facts relating to the issue which is the

subject of this opinion were stipulated by the parties.

The stipulated facts and accompanying exhibits are so found

and are hereby incorporated in this opinion.
                            - 7 -

     Petitioner was incorporated under the laws of the

Commonwealth of Pennsylvania.   At the time the instant

petition was filed on its behalf, petitioner's principal

place of business and mailing address was in Philadelphia,

Pennsylvania.   During each of the tax years in issue,

petitioner was the common parent of an affiliated group of

corporations, as defined in section 1504(a), and it filed a

consolidated Federal income tax return on behalf of itself

and the other members of the affiliated group as permitted

by section 1501.

     At all times material to this case, petitioner and

the other members of its affiliated group engaged in the

business of acquiring and developing oil, gas, and other

energy properties, of refining or otherwise preparing the

natural resources produced from the properties for sale

to customers, and of marketing and transporting those

products to customers both in the United States and abroad.

During the years in issue, petitioner and its affiliated

corporations earned income from various sources, domestic

and foreign, including income from interest, dividends, the

production of oil and gas and other hydrocarbons, and the

sale of products derived from the production of

hydrocarbons.
                            - 8 -

      Petitioner chose to use the foreign tax credit under

section 901(a) in computing the tax liability of its

affiliated group of corporations for consolidated return

years 1982, 1983, 1984, and 1986.   In computing the overall

limitation on the credit under section 904(a), petitioner

allocated and apportioned a portion of the interest expense

of each member of the affiliated group to sources without

the United States for purposes of computing the numerator

of the limiting fraction under section 904(a); i.e.,

taxable income from sources without the United States.

The following schedule sets forth the deduction for

interest claimed by each member of petitioner's affiliated

group for each of the years in issue, the portion of such

amount that was allocated and apportioned to sources

without the United States for each year, and the ratio of

the latter to the former:
                                     - 9 -
                                       Apportioned
                          Interest     to foreign      Ratio
       1982               expense     source income   percent

650 Leasing Co.           $682,931        $235,504     37.12
Sun Leasing Co.          4,729,086       2,729,628     57.72
666 Leasing Co.          4,072,539       2,138,083     52.50
670 Leasing Co.          1,830,136         853,210     46.62
673 Leasing Co.          1,627,381         727,928     44.73
675 Leasing Co.          1,983,276       1,002,744     50.56
652 Leasing Co.            794,330         356,448     44.87
Kee Leasing Co.            581,235         403,610     69.44
653 Leasing Co.            814,727         398,972     48.97
667 Leasing Co.          3,286,585       1,709,024     52.00
Millcreek Leasing Co.      830,407         202,492     24.38
DeSun Shipping              47,658          33,697     70.71
Eastern Sun Shipping        37,115          24,183     65.16
NY Sun Shipping          9,970,340       8,851,391     88.78
NJ Sun Shipping            143,340         116,170     81.05
PA Shipping                 46,423          29,294     63.10
Phil Sun Shipping       10,809,958       3,214,297     29.74
Western Sun Shipping        50,003          31,980     63.96
Sun Transport, Inc.      3,650,045       1,465,486     40.15
Sun Note Co.            31,066,253      31,066,253    100.00
North Sea Oil Co.           65,897          65,897    100.00
Totem Ocean Trailer         46,949          29,813     63.50

                        77,166,614      55,704,104


                                       Apportioned
                          Interest     to foreign      Ratio
       1983               expense     source income   percent

650 Leasing Co.           $612,220        $357,904     58.46
Sun Leasing Co.          4,736,241       2,808,118     59.29
666 Leasing Co.          4,084,197       2,580,396     63.18
670 Leasing Co.          1,756,214         973,645     55.44
652 Leasing Co.            714,282         312,641     43.77
Kee Leasing Co.            504,412         357,058     70.79
653 Leasing Co.            736,315         375,962     51.06
667 Leasing Co.          3,160,356       2,019,783     63.91
Millcreek Leasing Co.      742,214         365,707     49.27
NY Sun Shipping          9,849,306       8,573,395     87.05
NJ Sun Shipping            208,102         129,266     62.12
Phil Sun Shipping       10,688,995       3,437,299     32.16
Texas Sun Shipping          33,963          12,819     37.74
Tropic Sun Shipping        474,700         272,684     57.44
Sun Transport, Inc.      2,644,781         926,810     35.04
Heleasco Fifteen         1,444,639       1,297,009     89.78
Sun Note Co.            25,667,812      25,634,424     99.87

                        68,058,749      50,434,920
                                           - 10 -
                                              Apportioned
                              Interest        to foreign             Ratio
         1984                 expense        source income          percent

Kee Leasing Co.               $408,197           $154,339            37.81
666 Leasing Co.              4,083,327          1,964,080            48.10
670 Leasing Co.              1,669,360            610,485            36.57
650 Leasing Co.                536,038            270,003            50.37
652 Leasing Co.                613,066            176,024            28.71
653 Leasing Co.                636,635            118,974            18.69
667 Leasing Co.              3,018,359            885,134            29.33
Sun Leasing Co.              4,689,864          2,059,788            43.92
NY Sun Shipping              9,712,823          9,165,743            94.37
Phil Sun Shipping           10,551,646          4,687,164            44.43
Tropic Sun Shipping            644,883            313,703            48.64
Sun Transport, Inc.          3,091,754            985,633            31.88
                               1
Sun Oil Trading Co.              627,633           32,260             5.14
Sun Note Co.                25,854,099         25,693,399            99.38
North Sea Sun Oil Co.        7,681,288          7,541,569            98.18

                            73,818,972         54,658,298
     1
         One of petitioner's exhibits lists this amount as $2,114,469.   See p. 17, infra.


                                              Apportioned
                               Interest       to foreign             Ratio
         1986                  expense       source income          percent

Kee Leasing Co.                $213,410           $27,604            12.93
666 Leasing Co.               3,907,731         1,750,664            44.80
670 Leasing Co.               1,468,580           621,944            42.35
650 Leasing Co.                 404,732           189,415            46.80
Sun Leasing Co.               4,532,004         1,960,092            43.25
Millcreek Leasing Co.           435,448           102,064            23.44
Tropic Sun Shipping             644,829           242,814            37.66
Sun Transport, Inc.           2,356,829           650,044            27.58
Sunoco Overseas, Inc.           211.438           211,438           100.00
Sun Refining & Mktg. Co.     44,588,973         4,598,484            10.31
Sun Oil Trading Co.             549,406             8,918             1.62
Sun Co., Inc.               157,687,537         5,097,677             3.23
Sun Oil Intl.                 7,190,703         2,487,983            34.60
North Sea Sun Oil Co.        28,050,064        27,208,562            97.00
Claymont Investment Co.     217,180,793            47,426             0.02

                            469,422,477        45,205,129



         The parties have stipulated that "in most cases"

the interest expense of each member of petitioner's

affiliated group of corporations was apportioned "in

general accordance with the optional gross income method

[sic] of apportionment described in Treas. Reg. §1.861-

8(e)(2)(vi)."           The stipulation does not state which of the

optional gross income methods described by sec. 1.861-

8(e)(2)(vi), Income Tax Regs., was used in the case of any
                                 - 11 -

member of the group.       In any event, the following schedule

shows the gross income of each member of petitioner's

affiliated group of corporations for each of the subject

years, that member's gross income from sources without the

United States for each year, and the ratio of the latter

to the former:
                                            Foreign       Ratio
           1982            Gross income   gross income   percent

   650 Leasing Co.          $3,288,110     $1,221,496     37.15
   Sun Leasing Co.           6,872,415      3,966,133     57.71
   666 Leasing Co.           6,401,918      3,372,797     52.68
   670 Leasing Co.           4,733,818      2,214,708     46.78
   673 Leasing Co.           4,308,780      1,924,955     44.68
   675 Leasing Co.           3,987,511      2,016,544     50.57
   652 Leasing Co.           3,183,942      1,420,014     44.60
   Kee Leasing Co.           1,720,403      1,194,921     69.46
   653 Leasing Co.           3,209,671      1,576,737     49.12
   667 Leasing Co.           7,577,559      3,950,760     52.14
   Millcreek Leasing Co.     6,775,203      1,652,111     24.38
   DeSun Shipping            1,868,480      1,321,135     70.71
   Eastern Sun Shipping        340,725        222,010     65.16
   NY Sun Shipping           8,302,978      6,755,590     81.36
   NJ Sun Shipping            -814,965        575,083    -70.57
   PA Shipping               3,912,021      2,468,565     63.10
   Phil Sun Shipping         6,602,489      1,963,223     29.73
   Western Sun Shipping      2,574,519      1,646,584     63.96
   Sun Transport, Inc.      95,328,918     38,274,373     40.15
   Sun Note Co.             43,260,421     41,406,722     95.72
   North Sea Oil Co.        42,518,569     42,518,569    100.00
   Totem Ocean Trailer      92,031,992     57,380,743     62.35

                           347,985,477    219,043,773
                                   - 12 -
                                               Foreign      Ratio
        1983                 Gross income   gross income   percent

650 Leasing Co.               $2,593,100     $1,508,054     58.16
Sun Leasing Co.                6,973,146      4,151,644     59.54
666 Leasing Co.                8,943,399      5,644,013     63.11
670 Leasing Co.                4,132,347      2,304,872     55.78
652 Leasing Co.                2,523,829      1,104,364     43.76
Kee Leasing Co.                2,012,673      1,424,195     70.76
653 Leasing Co.                2,552,479      1,306,385     51.18
667 Leasing Co.                6,427,811      4,098,914     63.77
Millcreek Leasing Co.          8,220,982      4,050,674     49.27
NY Sun Shipping                7,917,134      6,891,523     87.05
NJ Sun Shipping                3,008,541      1,868,808     62.12
Phil Sun Shipping              6,930,169      2,228,559     32.16
Texas Sun Shipping             1,392,393        525,539     37.74
Tropic Sun Shipping            3,047,355      1,750,507     57.44
Sun Transport, Inc.           85,157,516     29,842,158     35.04
Heleasco Fifteen               2,415,666      2,168,805     89.78
Sun Note Co.                  44,530,627     42,711,487     95.91

                             198,779,167    113,580,501


                                               Foreign      Ratio
        1984                 Gross income   gross income   percent

Kee Leasing Co.               $2,014,039       $761,330     37.80
666 Leasing Co.                8,573,805      4,137,017     48.25
670 Leasing Co.                4,362,352      1,586,209     36.36
650 Leasing Co.                2,657,644      1,339,771     50.41
652 Leasing Co.                2,557,004        731,691     28.62
653 Leasing Co.                2,592,171        483,157     18.64
667 Leasing Co.                6,563,855      1,936,224     20.50
Sun Leasing Co.                7,404,599      3,269,459     44.15
NY Sun Shipping                9,454,505      8,921,975     94.37
Phil Sun Shipping              5,129,727      2,278,684     44.42
Tropic Sun Shipping            4,004,764      1,948,117     48.64
Sun Transport, Inc.           73,123,906     23,311,476     31.88
Sun Oil Trading Co.           20,037,455        710,113      3.54
Sun Note Co.                  40,344,826     40,094,056     99.38
North Sea Sun Oil Co.         23,924,318     17,319,539     72.39

                             212,744,970    108,828,818


                                               Foreign      Ratio
        1986                 Gross income   gross income   Percent

Kee Leasing Co.              $2,013,346        $260,455     12.94
666 Leasing Co.               7,082,756       3,172,987     44.80
670 Leasing Co.               3,533,401       1,496,424     42.35
650 Leasing Co.               2,038,955         954,294     46.80
Sun Leasing Co.               6,194,365       2,679,882     43.26
Millcreek Leasing Co.           305,752         -83,676     27.37
Tropic Sun Shipping           3,986,919       1,501,298     37.66
Sun Transport, Inc.          79,520,790      21,932,881     27.58
Sunoco Overseas, Inc.          -108,199         290,314    100.00
Sun Refining & Mktg. Co.    672,597,605       1,095,517      0.16
Sun Oil Trading Co.          13,481,454       4,673,000     34.66
Sun Co., Inc.               760,884,991      23,864,572      3.14
Sun Oil Intl.                10,593,916       6,769,393     34.55
North Sea Sun Oil Co.        36,565,327      36,394.917     99.53
Claymont Investment Co.     513,112,873         111,203     00.02

                           2,120,804,251    105,113,461
                           - 13 -

In allocating and apportioning each member's interest

expense to sources without the United States under one

of the optional gross income methods described by section

1.861-8(e)(2)(vi), Income Tax Regs., petitioner started

with the gross amount of each member's interest expense

for the taxable year and did not offset that amount by

the interest income earned by that member during the year.

     As mentioned above, petitioner chose to use the

foreign tax credit under section 901(a) in computing the

tax liability of its affiliated group of corporations for

consolidated return years 1982, 1983, 1984, and 1986.    As

to each of those years, the amount of foreign taxes for

which a taxpayer could claim credit was subject to the

overall limitation of section 904.    Under that limitation,

the amount of foreign tax credit could not exceed the

tentative U.S. tax for the year (i.e., the U.S. tax before

application of the foreign tax credit) multiplied by a

fraction, the numerator of which is the taxable income from

sources without the United States and the denominator of

which is the entire taxable income.    Sec. 904(a).

     Generally, in the case of an affiliated group of

corporations, the foreign tax credit is determined on a

consolidated basis.   Sec. 1.1502-4(c), Income Tax Regs.

In computing the overall limitation under section 904(a)
                           - 14 -

for an affiliated group, the numerator of the limiting

fraction is an amount equal to the total of the separate

taxable incomes of the members of the group from sources

without the United States, with certain adjustments that

are not material to this case.   See sec. 1.1502-4(d)(1),

Income Tax Regs.   The denominator of the limiting fraction

under section 904(a) is the consolidated taxable income of

the group computed in accordance with section 1.1502-11,

Income Tax Regs.   Sec. 1.1502-4(d)(2), Income Tax Regs.

Thus, for each of the subject consolidated return years,

petitioner was required to compute the "taxable income from

sources without the United States" of each member of its

affiliated group of corporations.   Sec. 904(a).   The total

of those amounts is the numerator of the limiting fraction

under section 904(a).

     In these proceedings, petitioner seeks to make two

changes in the method used to allocate and apportion

interest expenses for purposes of computing each member's

taxable income from sources without the United States.

First, petitioner seeks to apportion the interest expenses

of each member of its affiliated group using the asset

method described in section 1.861-8(e)(2)(v), Income Tax

Regs., for tax years 1982, 1983, and 1984, and using one

of the optional gross income methods described by section
                           - 15 -

1.861-8(e)(2)(vi), Income Tax Regs., for tax year 1986.

As mentioned above, petitioner had used one of the

optional gross income methods described by section 1.861-

8(e)(2)(vi), Income Tax Regs., in apportioning interest

expenses on each of the subject returns.   Respondent

concedes that petitioner is entitled to make this change,

as long as all members joining the 1986 return use one of

the optional gross income methods described by section

1.861-8(e)(2)(vi), Income Tax Regs.

     The second change sought by petitioner, the change

at the heart of the instant controversy, involves

petitioner's assertion that each member's interest expense

to be allocated and apportioned under section 1.861-

8(e)(2), Income Tax Regs., for purposes of computing the

overall limitation under section 904(a), is "net interest

expense", i.e., interest expense for the year less interest

income but not less than zero, rather than gross interest

expense.   Respondent asserts that this change is improper.

     To quantify petitioner's position, the following

schedule sets forth the interest expense incurred by each

member of petitioner's affiliated group of corporations,

the interest income earned by that member, and the net

interest expense of that member; i.e., interest expense

less interest income but not less than zero:
                                  - 16 -
                             Interest       Interest    Net interest
        1982                 expense         income       expense

650 Leasing Co.               $682,931     $1,379,522       -0-
Sun Leasing Co.              4,729,086      1,512,776   $3,216,310
666 Leasing Co.              4,072,539      1,904,855    2,167,684
670 Leasing Co.              1,830,136      1,740,970       89,166
673 Leasing Co.              1,627,381      1,253,296      374,085
675 Leasing Co.              1,983,276        836,661    1,146,615
652 Leasing Co.                794,330      1,285,273       -0-
Kee Leasing Co.                581,235         13,373      567,862
653 Leasing Co.                814,727      1,309,988       -0-
667 Leasing Co.              3,286,585      2,639,109      647,476
Millcreek Leasing Co.          830,407      1,357,133       -0-
DeSun Shipping                  47,658        135,470       -0-
Eastern Sun Shipping            37,115         82,228       -0-
NY Sun Shipping              9,970,340        854,008    9,116,332
NJ Sun Shipping                143,340         16,205      127,135
PA Shipping                     46,423        133,771       -0-
Phil Sun Shipping           10,809,958        448,677   10,361,281
Western Sun Shipping            50,003         66,869       -0-
Sun Transport Inc.           3,650,045         99,840    3,550,205
Sun Note Co.                31,066,253     32,754,418       -0-
North Sea Oil Co.               65,897      1,176,482       -0-
Totem Ocean Trailer             46,949      1,668,617       -0-

                            77,166,614     52,669,541   31,364,151


                             Interest       Interest    Net Interest
        1983                 expense         income       expense

650 Leasing Co.               $612,220       $684,172       -0-
Sun Leasing Co.              4,736,241      1,581,401   $3,154,840
666 Leasing Co.              4,084,197      1,707,485    2,376,712
670 Leasing Co.              1,756,214      1,139,007      617,207
652 Leasing Co.                714,282        631,498       82,784
Kee Leasing Co.                504,412          6,765      497,647
653 Leasing Co.                736,315        658,732       77,583
667 Leasing Co.              3,160,356      1,489,361    1,670,995
MillCreek Leasing Co.          742,214      2,132,982       -0-
NY Sun Shipping              9,849,306        727,159    9,122,147
NJ Sun Shipping                208,102        449,738       -0-
Philadelphia Sun Shipping   10,688,995        855,141    9,833,854
Texas Sun Shipping              33,963        704,193       -0-
Tropic Sun Shipping            474,700        569,955       -0-
Sun Transport, Inc.          2,644,781        980,197    1,664,584
Heleasco Fifteen             1,444,639        246,861    1,197,778
Sun Note Co.                25,667,812     37,161,016       -0-

                            68,058,749     51,725,663   30,296,131
                                  - 17 -
                              Interest      Interest     Net interest
          1984                expense        income        expense

Kee Leasing Co.                $408,197       $10,538      $397,659
666 Leasing Co.               4,083,327     2,209,163     1,874,164
670 Leasing Co.               1,669,360     1,369,504       299,856
650 Leasing Co.                 536,038       715,947        -0-
652 Leasing Co.                 613,066       671,202        -0-
653 Leasing Co.                 636,635       704,840        -0-
667 Leasing Co.               3,018,359     1,611,875     1,406,484
Sun Leasing Co.               4,689,864     2,044,830     2,645,034
NY Sun Shipping               9,712,823       532,530     9,180,293
Phil Sun Shipping           10,551,646        676,120     9,875,526
Tropic Sun Shipping             644,883     1,040,764        -0-
Sun Transport, Inc.           3,091,754        35,223     3,056,531
                            1
Sun Oil Trading Co.           2,114,469    16,303,956        -0-
Sun Note Co.                25,854,099     33,533,894        -0-
North Sea Oil Co.             7,681,288     2,196,279     5,485,009

                            75,305,808     63,656,665    34,220,556
     1
         See 

.

                              Interest       Interest     Net interest
                 1986         expense         income        expense

Kee Leasing Co.                $213,410         $9,844      $203,566
666 Leasing Co.               3,907,731        736,783     3,170,948
670 Leasing Co.               1,468,580        540,553       928,027
650 Leasing Co.                 404,732        130,367       274,365
Sun Leasing Co.               4,532,004        834,601     3,697,403
Millcreek Leasing Co.           435,448        662,752        -0-
Tropic Sun Shipping             644,829      1,148,919        -0-
Sun Transport, Inc.           2,356,829        646,275     1,710,554
Sunoco Overseas, Inc.           211,438        189,663        21,775
Sun Refining & Mkt., Inc.    44,588,973     23,675,379    20,913,594
Sun Oil Trading Co.             549,406        317,610       231,796
Sun Co., Inc.               157,687,537        937,176   156,750,361
Sun Oil Int.                  7,190,703     12,824,523        -0-
North Sea Oil Co.            28,050,064      1,784,106    26,265,958
Claymont Investment Co.     217,180,793    505,319,941        -0-

                            469,422,477   549,758,492    214,168,347



Petitioner argues that it is entitled to use the amount in

column three of the above schedule, i.e., the net interest

expense of each member of its affiliated group, as the

starting point for allocating and apportioning that

member's interest expense under section 1.861-8(e)(2),

Income Tax Regs.

         The parties have stipulated the amount of each

member's interest expense to be allocated and apportioned

to sources without the United States depending upon whether
                          - 18 -

netting is or is not permitted.    These stipulations are

summarized in the appendix to this Opinion.

     In the appendix, each member's interest expense for

1982, 1983, and 1984 is apportioned to sources without the

United States in accordance with the asset method described

by section 1.861-8(e)(2)(v), Income Tax Regs.    The parties

have stipulated the ratio of each member's assets which

relates to activities and properties that generated foreign

source income during each year.    See generally sec. 1.861-

8(e)(2)(v), Income Tax Regs.   Using that asset ratio, the

amount of a member's interest expense to be apportioned to

sources without the United States is computed, if netting

is not permitted, by multiplying the ratio and the member's

gross interest expense, or, if netting is permitted, by

multiplying the ratio and the member's net interest

expense.

     In the appendix, each member's interest expense for

1986 is apportioned to sources without the United States

in accordance with one of the optional gross income methods

described by section 1.861-8(e)(2)(vi), Income Tax Regs.

Generally, under that provision, assuming certain condi-

tions are met, the deduction for interest is apportioned to

sources within or without the United States ratably on the

basis of a taxpayer's gross income.    See 

-

     As shown in the appendix, the parties have stipulated

two sets of gross income ratios for 1986, one set to be

used assuming that netting is not permitted and the other

set to be used assuming that netting is permitted.    The

amount of a member's interest expense to be apportioned to

sources without the United States is computed, if netting

is not permitted, by multiplying the first gross income

ratio and the member's gross interest expense, or, if

netting is permitted, by multiplying the second ratio

and the member's net interest expense.   The appendix has

two schedules for 1986, one schedule summarizing the

apportionment of gross interest (i.e., no netting) and

one summarizing the apportionment of net interest (i.e.,

netting).

     It appears that in computing the second set of gross

income ratios for 1986, the ratios to be used if netting

is permitted, the parties have adjusted the gross income of

each member by subtracting therefrom the amount of interest

income that is offset by interest expense.   For example, in

the case of Kee Leasing Co., the first income ratio of

12.94 percent, the ratio to be used in apportioning

interest if netting is not permitted, was computed by

dividing the company's gross income from sources without

the United States, $260,455, by the company's gross income,
                             - 20 -

$2,013,345.   On the other hand, the second income ratio of

13 percent, the ratio to be used in apportioning interest

if netting is permitted, was computed after the amount of

netted interest income, $9,844, was subtracted from the

company's gross income, the denominator of the fraction.

Thus, the second ratio of 13 percent was computed by

dividing $260,455, the company's gross income from sources

without the United States, by $2,003,501, the company's

total gross income less the amount of netted interest

($2,013,345 minus $9,844).

     Similar adjustments were made to the gross income of

each of the other 14 members of petitioner's affiliated

group for purposes of computing the second gross income

ratio; i.e., the ratio to be used in computing the interest

expense to be apportioned to sources without the United

States, assuming that netting is permitted.

     Furthermore, in the case of one of the 15 members of

petitioner's affiliated group of corporations, North Sea

Sun Oil Co., a similar adjustment was made to the numerator

of the fraction that constitutes the gross income ratio.

That is, the interest income earned by that company during

1986, $1,784,106, was subtracted from the company's foreign

source gross income, $36,394,917, to arrive at $34,610,811,

the numerator of the fraction.    That amount was divided
                           - 21 -

by the excess of the company's total gross income,

$36,565,327, over its interest income, $1,784,106, or

$34,781,221, to arrive at the gross income ratio of 99.51

percent.

     Thus, in computing the second gross income ratio for

North Sea Sun Oil Co. under section 1.861-8(e)(2)(vi),

Income Tax Regs., the ratio to be used if netting is

permitted, the interest income earned by North Sea Sun Oil

Co. during 1986 was subtracted from both the numerator and

the denominator of the fraction.    The interest income

earned during 1986 by each of the other 14 members of

plaintiff's affiliated group was subtracted only from the

denominator of the fraction in computing the second gross

income ratio for each of those companies.    We infer from

this that the interest income earned by North Sea Sun Oil

Co. in 1986 constituted gross income from sources without

the United States, whereas the interest income earned by

each of the other members of petitioner's affiliated group

for 1986 constitutes gross income from sources within the

United States.

     The following schedule summarizes the revenue impact

of the position of each of the parties with respect to the

subject issue.   It shows, based upon the parties'

stipulation, the aggregate interest expense apportioned to
                                      - 22 -

sources without the United States for each of the years in

issue as claimed on petitioner's consolidated returns, the

aggregate interest expense to be apportioned to foreign

sources if there is no netting of interest expense and

interest income, and the aggregate amount to be so

apportioned if there is netting of interest expense and

interest income.            The last column of the schedule shows the

difference between the amount of interest to be apportioned

to sources without the United States, assuming that there

is no netting, and the amount of interest to be so

apportioned, assuming that there is netting:

  Interest expense allocated and apportioned to sources without the United States

     Year      Per return       No netting         Netting        Difference

    1982       $55,704,104      $55,155,126     $17,444,643      $37,710,483
    1983        50,434,920       47,362,922      17,200,130       30,162,792
    1984        54,658,298       50,150,909      19,831,268       30,319,641
    1986        45,205,129       45,517,890      37,689,610        7,828,280

               206,002,451      198,186,847      92,165,651      106,021,196


Thus, as shown above, if there is netting, then the

aggregate interest expense to be allocated and apportioned

to sources without the United States in computing the

overall limitation on petitioner's foreign tax credit under

section 904(a) would be substantially less for each of the

4 years in issue than the interest expense to be allocated

and apportioned to sources without the United States if

there is no netting.            This difference is $37,710,483,

$30,162,792, $30,319,641, and $7,828,280, for the years in
                           - 23 -

issue, respectively.   Thus, the effect of netting would be

to substantially increase petitioner's income from sources

without the United States, the numerator of the limiting

fraction under section 904(a), and to substantially

increase the amount of petitioner's foreign tax credit for

each of the years in issue.

     Both parties rely on the regulations promulgated under

the source rules, viz sections 861 through 864, especially

section 1.861-8(e)(2), Income Tax Regs., to support their

position that netting is permitted or that netting is not

permitted.   Petitioner does not contend that the

regulations are contrary to the statute or unlawful in

any respect.   Therefore, as presented by the parties, the

issue in this case is whether the netting of interest

income and interest expense is permitted by the regulations

promulgated under sections 861 through 864, principally

section 1.861-8(e)(2), Income Tax Regs., that were in

effect during the years 1982, 1983, 1983, and 1986,

generally referred to herein as the subject regulations.

     At the outset, we note that the principal regulation

at issue in this case, section 1.861-8(e)(2), Income Tax

Regs., was adopted on January 3, 1977, effective for

taxable years beginning after December 31, 1976
                             - 24 -

(hereinafter referred to as the 1977 Regulation).

42 Fed. Reg. 1197 (Jan. 6, 1977).

     In 1988, the Secretary of the Treasury issued

temporary regulations dealing with the allocation and

apportionment of interest expense and certain other

expenses for purposes of the foreign tax credit rules and

certain other international tax provisions to reflect the

revisions to those rules made by the passage of the Tax

Reform Act of 1986, Pub. L. 99-514, sec. 1215, 100 Stat.

2544.   Section 1.861-9T(a), Temporary Income Tax Regs.,

53 Fed. Reg. 35477 (Sept. 14, 1988), superseded the 1977

regulation for years beginning after December 31, 1986.

Section 1.861-9T(a) contains virtually the same language

found in section 1.861-8(e)(2)(i) and (ii) regarding the

allocations and apportionment of interest expenses.    In

addition, section 1.861-9T(a), Temporary Income Tax 

, explicitly provides that "the term interest refers

to the gross amount of interest expense incurred by a

taxpayer in a given year."    (Emphasis added.)   Therefore,

the 1988 temporary regulation explicitly prohibits netting

for tax years beginning after December 31, 1986.     The 1988

temporary regulations were not given retroactive effect

and thus do not apply to the years in issue in this case.
                            - 25 -

See sec. 1.861-8T(h), Temporary Income Tax Regs., 53 Fed.

Reg. 35477 (Sept. 14, 1988).

     We do not agree with petitioner's contention that,

by promulgating the new rules without retroactive effect,

the Secretary of the Treasury indicated "that the express

restrictive language requiring the use of gross interest

expense for purposes of allocation and apportionment was

intended as a change, rather than a clarification, of prior

law."   To the contrary, the 1988 temporary regulations,

including section 1.861-9T(a), Temporary Income Tax 

, were promulgated to reflect the revisions made by

the Tax Reform Act of 1986, including the enactment of

section 864(e), which substantially changed some of the

rules for the allocation and apportionment of interest

expenses.    These new provisions were made effective, for

the most part, for tax years beginning after December 31,

1986.   Tax Reform Act of 1986, Pub. L. 99-514, sec.

1215(c)(1), 100 Stat. 2545.    It was appropriate to make

the regulations reflecting those changes effective at the

same time.   In these circumstances, we do not believe that

promulgating the new rules without retroactive effect

suggests that the sentence in section 1.861-9T(a),

Temporary Income Tax 

, quoted above, containing

the words, "the gross amount of interest expense", was
                             - 26 -

intended as a change, rather than a clarification, of prior

law.

       The subject regulations are intended to be used in

conjunction with certain "operative sections" of the Code

which require the determination of the taxable income of

the taxpayer from specific sources or activities.      See

sec. 1.861-8(f)(1), Income Tax Regs.     The overall

limitation on the foreign tax credit provided in section

904(a) is one such operative section.     See 

subject regulations, the first step in

determining a taxpayer's taxable income from a particular

source or activity is to categorize the taxpayer's gross

income into different groupings.      See sec. 1.861-8(a)(1),

(2), (4), Income Tax Regs.    The regulations use the term

"statutory grouping of gross income" to mean the gross

income from a specific source or activity which must first

be determined in order to arrive at taxable income from

such specific source or activity under an operative

section.    Sec. 1.861-8(a)(4), Income Tax Regs.    Gross

income from other sources or activities is referred to

as the "residual grouping of gross income".      

limitation of section 904(a), the

operative section in this case, requires the taxpayer to

determine taxable income from sources without the United
                           - 27 -

States.   Thus, the "statutory grouping of gross income" in

this case is gross income from sources without the United

States and the "residual grouping of gross income" is gross

income from sources within the United States.     See sec.

1.861-8(a)(4), (f)(1), Income Tax Regs.

     The term "gross income from sources without the United

States", the statutory grouping of gross income in this

case, consists of those items of gross income specified in

section 862(a), plus the items of gross income allocated

or apportioned to such sources in accordance with section

863(a).   Sec. 1.861-1(a)(2), Income Tax Regs.    Similarly,

"gross income from sources within the United States", the

residual grouping of gross income in this case, consists

of those items of gross income specified in section 861(a),

plus the items of gross income allocated or apportioned

to such sources in accordance with section 863(a).     Sec.

1.861-1(a)(1), Income Tax Regs.

     For example, in the case of interest income, section

861(a)(1) provides that, as a general rule, the interest

on bonds, notes, or other interest-bearing obligations of

residents of the United States, corporate or otherwise,

shall be treated as income from sources within the United

States.   See sec. 1.861-2(a), Income Tax Regs.    Section

862(a)(1) provides that interest income other than that
                          - 28 -

derived from sources within the United States shall be

treated as income from sources without the United States.

See sec. 1.862-1(a)(1)(i), Income Tax Regs.

     The record in the instant case does not expressly

provide the source of the interest income earned by any

member of petitioner's affiliated group of corporations

during any of the years in issue.   Nevertheless, we infer

that the interest income of petitioner's affiliated

corporations, for the most part, would be treated under

the source rules as U.S. source income.   Otherwise, if the

interest income of petitioner's affiliated corporations

were treated as foreign source income, then, in each case,

the interest income would be included in the numerator of

the limiting fraction under section 904(a) and would offset

the interest expenses in that grouping.   Thus, if the

interest income of petitioner's affiliated corporations

were foreign source income, netting would have little or no

impact on the amount of foreign tax credit.   This inference

is confirmed in the case of the interest income earned by

the members of petitioner's group for 1986, as discussed

above.

     After finding the source of each item of the

taxpayer's gross income and grouping the items of gross

income into the statutory and residual groupings, the next
                             - 29 -

step in determining taxable income from a specific source

or activity is to allocate and apportion the taxpayer's

"expenses, losses, and other deductions" to each of the

groupings of gross income.    Sec. 1.861-8(a)(2), (b), and

(c), Income Tax Regs.   Taxable income from a particular

source or activity is the difference between the aggregate

items of gross income in that grouping and the sum of the

expenses, losses, and other deductions that are properly

allocated and apportioned thereto, and a ratable portion

of any expenses, losses, or other deductions that cannot

definitely be allocated to an item or class of gross

income.   See secs. 861(b), 862(b); secs. 1.861-1, 1.861-

8(a)(1), Income Tax Regs.

     The regulations provide rules of general applicability

governing the allocation and apportionment of expenses,

losses, and other deductions, see sec. 1.861-8(a), (b),

(c), and (d), Income Tax Regs., as well as rules governing

the allocation and apportionment of specific deductions,

see sec. 1.861-8(e)(2) through (11), Income Tax Regs.

Specific rules for the allocation and apportionment of

interest expense are provided in section 1.861-8(e), Income

Tax Regs.

     The principal rule of general applicability is that a

taxpayer's expenses, losses, and other deductions are to be
                             - 30 -

allocated to the "class of gross income" to which each

deduction is "definitely related".     Sec. 1.861-8(a)(3),

(b)(1), Income Tax Regs.   A deduction is considered

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 such class of gross

income is derived and, thus, the deduction bears a factual

relationship to the class of gross income.     Sec. 1.861-

8(b)(1) and (2), Income Tax Regs.     Classes of gross income

are not predetermined but must be determined on the basis

of the deductions to be allocated.     Sec. 1.861-8(b)(1),

Income Tax Regs.   They may consist of one or more items of

gross income enumerated in section 61, such as compensation

for services, gross income derived from business, gains

derived from dealings in property, interest, rents,

royalties, dividends, etc.    Sec. 1.861-8(a)(3), (b)(1),

Income Tax Regs.

     If a deduction is definitely related to a class of

gross income that is included in more than one grouping of

gross income, or if the deduction is definitely related to

all of the taxpayer's gross income, then the regulations

further provide that the deduction shall be apportioned "by

attributing the deduction to gross income (within the class

to which the deduction has been allocated) which is in the
                            - 31 -

statutory grouping or in each of the statutory groupings

and to gross income (within the class) which is in the

residual grouping."   Sec. 1.861-8(c)(1), Income Tax Regs.

This attribution must reflect to a reasonably close extent

the factual relationship between the deduction and the

grouping of gross income.   See 

of

apportionment for a particular deduction can take into

consideration various bases and factors, such as a

comparison of units sold attributable to the statutory

grouping and to the residual grouping, a comparison of

the amount of gross sales or receipts, a comparison of the

costs of goods sold, a comparison of profit contribution,

a comparison of expenses incurred, assets used, salaries

paid, space utilized, and time spent which are attributable

to the activities or properties giving rise to the class of

gross income, and a comparison of the amount of gross

income in the statutory grouping with the amount in the

residual grouping.    See 

the deduction is not definitely related to

any gross income, then the regulations provide that it is

to be apportioned ratably between the statutory grouping

and (or among the statutory groupings) and the residual

grouping in proportion to the amount of gross income in
                           - 32 -

each grouping.   See sec. 1.861-8(b)(5), (c)(2), Income

Tax Regs.

     Thus, under the rules of general applicability, the

approach of the regulations, with several exceptions, is

that every deduction has a definite factual relationship to

a particular class of gross income which constitutes less

than all of the taxpayer's gross income.   Based upon that

approach, the rules of general applicability require each

deduction to be allocated to the related class of gross

income and to be apportioned, on some reasonable basis, to

the statutory and residual groupings of gross income.

     The regulations take a different approach in the

specific rules governing the allocation and apportionment

of interest expenses, set forth in section 1.861-8(e)(2),

Income Tax Regs.   The regulations describe this approach

as follows:


          (2) Interest–-(i) In general. The method
     of allocation and apportionment for interest set
     forth in this paragraph (e)(2) is based on the
     approach that money is fungible and that interest
     expense is attributable to all activities and
     property regardless of any specific purposes for
     incurring an obligation on which interest is
     paid. This approach recognizes that all
     activities and property require funds and that
     management has a great deal of flexibility as to
     the source and use of funds. Normally, creditors
     of a taxpayer subject the money advanced to the
     taxpayer to the risk of the taxpayer's entire
     activities and look to the general credit of the
                           - 33 -

     taxpayer for payment of the debt. When money is
     borrowed for a specific purpose, such borrowing
     will generally free other funds for other
     purposes and it is reasonable under this approach
     to attribute part of the cost of borrowing to
     such other purposes. For the method of
     determining the interest deduction allowed to
     foreign corporations under section 882(c), see
     sec. 1.882-5. [Sec. 1.861-8(e)(2)(i), Income Tax
     Regs.]


This is the provision of the regulations on which

petitioner principally relies, sec. 1.861-8(e)(2)(i),

Income Tax Regs.   Based on the above approach, the

regulations provide as follows:


     the aggregate of deductions for interest shall
     be considered related to all income producing
     activities and properties of the taxpayer and,
     thus, allocable to all the gross income which
     the income producing activities and properties
     of the taxpayer generate, have generated, or
     could reasonably have been expected to generate.
     [Sec. 1.861-8(e)(2)(ii), Income Tax Regs.]


     After stating the general rule in section 1.861-

8(e)(2)(i), Income Tax Regs., that interest expense is

"allocable to all gross income" of the taxpayer, the

regulations provide various methods to apportion the

taxpayer's interest expense between the statutory

grouping of gross income (or among the statutory groupings

of gross income) and the residual grouping.   See sec.

1.861-8(e)(2)(v) and (vi), Income Tax Regs.   Under the
                            - 34 -

"asset method", the deduction for interest is apportioned,

generally, in accordance with the value (book value or fair

market value) of the assets utilized or invested in the

activity or property.    See sec. 1.861-8(e)(2)(v), Income

Tax Regs.   This is the method that petitioner wishes to use

for tax years 1982, 1983, and 1984, as mentioned above.

Under the "optional gross income methods", the deduction

for interest is apportioned, generally, on the basis of the

gross income in the statutory grouping or groupings and in

the residual grouping.    Sec. 1.861-8(e)(2)(vi), Income Tax

Regs.   This is the method that petitioner wishes to use for

tax year 1986, as mentioned above.

     Significantly, the regulations provide an exception

that applies in the case of interest incurred specifically

to purchase specific property.    See sec. 1.861-8(e)(2)

(iv), Income Tax Regs.    In that case, the interest is

treated as definitely related to the gross income derived

from the property and is apportioned accordingly.    See 

for this exception to apply, certain facts and

circumstances enumerated in the regulations must be found.

These include the fact that the indebtedness was incurred

to purchase the specific property, the fact that the

proceeds of the loan were actually applied to that purpose,

the fact that the property is the only security for the
                           - 35 -

loan, the fact that the return (cashflow) on or from the

property will be sufficient to satisfy the payments under

the loan, and the fact that the loan agreements place

restrictions on the disposal or use of the property.    See

is found that an interest deduction is

definitely related solely to specific property, the

interest deductions are allocated solely to the gross

income derived from the specific property.    See sec. 1.861-

8(e)(2)(iv)(B), Income Tax Regs.    Thus, the income from the

specific property is placed in a grouping of gross income

in accordance with the usual rules for sourcing gross

income, see secs. 1.861-2 through 1.861-7, Income Tax

Regs., and the interest deduction is directly allocated to

such gross income, see sec. 1.861-8(e)(2)(iv)(B), Income

Tax Regs.

      Finally, in the case of nonbusiness interest, such

as interest paid by an individual on a mortgage on his

personal residence, the interest is treated as not

definitely related to any class of gross income, see sec.

1.861-8(b)(5), (c)(2), Income Tax Regs., and is apportioned

ratably between the statutory grouping (or among the

statutory groupings) and the residual grouping in
                           - 36 -

proportion to the amount of gross income in each grouping,

see sec. 1.861-8(e)(2)(iii), Income Tax Regs.

     Petitioner argues that, under the version of the

section 861 regulations in effect during the years in

issue, it "may allocate and apportion net interest, rather

than gross, interest expense" in calculating taxable income

from sources without the United states for purposes of

section 904(a).   Petitioner's position is based on its

reading of section 1.861-8(e)(2)(i), Income Tax Regs.,

which is quoted above.   Petitioner emphasizes that section

1.861-8(e)(2)(i), Income Tax Regs., states, in general,

that the method of allocation and apportionment for

interest is based on the approach that "money is fungible",

and recognizes that "all activities and property require

funds" and that "management has a great deal of flexibility

as to the source and use of funds."   

that the regulation refers to "interest" as "the cost of

borrowing" in the context of "the fungibility of money".

Based thereon, petitioner argues that the language of the

regulation "raises a contextual ambiguity with respect to

the precise definition of 'interest' and 'the cost of

borrowing'."   According to petitioner, the term "interest"

can mean either net interest or gross interest, depending

on the context.   Petitioner argues that, in the context of
                          - 37 -

the subject regulation which is based upon the fungibility

of money approach, and, absent an express rule to the

contrary, the term "interest" should be recognized to mean

net interest expense; i.e., gross interest expense less

interest income.

     Petitioner asserts that the following "simplified

example", demonstrates that recognizing "interest" or "the

cost of borrowing" as net interest expense, implements the

fungibility of money principle:


     Assume * * * that a business needs $800,000,
     and has $1 million in short-term instruments
     bearing interest at 10 percent per year, and the
     capacity to borrow funds with no fees and at 10
     percent per year. The business can obtain the
     $800,000 by reducing its holding of short-term
     interest bearing instruments or by borrowing.
     Either choice has exactly the same effect on the
     net income of the business. If the business
     borrows, interest expense will increase by
     $80,000 per year; if the business sells the
     instruments, interest income will decrease by
     $80,000 per year.


Petitioner argues that the two sources of funds in the

above example, incurring debt and selling short-term

interest bearing assets, are fungible and should be treated

as fungible under the source rules, as would take place by

recognizing interest as net interest expense.   Petitioner

also argues that "a corollary to the fungibility of these

two sources of funds is the fact that reduced interest
                          - 38 -

income is essentially equivalent to increased interest

expense."

     Petitioner gives the following variation of the above

example to illustrate its position that taxpayers in the

same economic situation should be treated the same by

interpreting "interest" and "cost of borrowing", as used

in section 1.861-8(e)(2)(i), Income Tax Regs., to mean net

interest:


     Suppose business A has an immediate need of
     $800,000 and uncertain future needs, and a line
     of credit of $1 million at 10 percent, and
     immediately draws $800,000 on the line of credit.
     The interest expenses on the $800,000 would be
     $80,000, rather than $100,000. In contrast,
     business B has a substantially identical need of
     $800,000 immediately and uncertain future needs,
     but has no line of credit. So, business B
     obtains a loan from a bank for $1 million and
     invests the surplus $200,000 in short-term
     instruments bearing 10 percent. Although
     business B's gross interest expense would be
     $100,000, its cost of borrowing would be best
     described as $80,000 ($100,000-$20,000).


Petitioner argues that in the context of section 1.861-

8(e)(2), Income Tax Regs., which is based upon the

"fungibility of money" and management's "flexibility as to

sources of funds", the two firms in the above example are

in the same economic situation and the cost of borrowing

incurred by both firms should be treated the same, as would

take place by recognizing interest as net interest expense.
                            - 39 -

     Petitioner relies heavily on the Opinion of this Court

in Bowater, Inc., & Subs. v. Commissioner, 

(1993), revd. 

(2d Cir. 1997), involving the

same issue, viz, whether a taxpayer may offset interest

income and interest expense in determining the amount of

the interest deduction to be allocated and apportioned

under section 1.861-8(e)(2), Income Tax Regs.     In that

case, the issue arose in the context of computing the

combined taxable income (CTI) of the taxpayer and its

domestic international sales corporation (DISC)

attributable to qualified export receipts derived from the

sale by the DISC of export property.     See Bowater, Inc.,

& Subs. v. 

.      Generally, in computing

CTI attributable to qualified export receipts, expenses are

to be allocated and apportioned in a manner consistent with

the rules set forth in section 1.861-8, Income Tax Regs.

Sec. 1.994-1(c)(6)(iii), Income Tax Regs.     In Bowater,

Inc., & Subs. v. 

, we held that interest

expenses can be offset by interest income before the

net interest expense is apportioned under section 1.861-

8(e)(2), Income Tax Regs.   

that we should follow Bowater, Inc.,

& Subs. v. 

, in the instant case, as we

have on two prior occasions, Coca Cola Co. v. Commissioner,
                           - 40 -

, 6 (1996), and Computervision Intl. Corp. v.

Commissioner, T.C. Memo. 1996-131, vacated and remanded

(1st Cir. 1999).   Petitioner also argues that

we should reject the "faulty" reasoning of the Court of

Appeals for the Second Circuit in its opinion reversing

this Court's Bowater, Inc. opinion.   See Bowater, Inc.,

& Subs. v. Commissioner, 

(2d Cir. 1997).

     Respondent argues that the subject regulations are not

ambiguous.   To the contrary, respondent states that the

"plain language of the Regulations" promulgated under

section 861 "[mandates] the apportionment of interest

expense among all income producing activities, including

those that generate interest income, and [rejects] the

'netting' of interest expense and interest income".

Respondent argues that this is made clear by two examples

in the regulations, Examples (1) and (24) of section

1.861-8(g), Income Tax Regs., in which "'gross' interest

expense, i.e., without reduction for interest income, [is

apportioned] among each of the hypothetical taxpayer's

income producing activities, including those that generate

interest income."   Respondent also argues that petitioner

misinterprets "the Regulation's fungibility concept".

Finally, respondent argues that petitioner's position

ignores the fact that the regulations promulgated under
                            - 41 -

section 861 apportion "deductions" which, in the case of

interest expenses means the amount deductible under section

163.    In this connection, respondent points out that

section 1.861-8(a)(2), Income Tax Regs., is headed

"Allocation and apportionment of deductions in general",

and that "there is nothing in the Regulations suggesting

that the word 'deduction' should be defined differently

under Treas. Reg. §1.861-8 than elsewhere in the Internal

Revenue Code."

       We disagree with petitioner that the language of

section 1.861-8(e)(2)(i), Income Tax Regs., "raises a

contextual ambiguity with respect to the precise

definition of the terms 'interest expense' and 'the cost

of borrowing.'"    We also disagree that those terms were

intended, or can be interpreted in the context of section

1.861-8(e)(2), Income Tax Regs., to refer to "net interest

expense."    In our view, the allocation and apportionment

of net interest expense under section 1.861-8(e)(2), Income

Tax Regs., is not permitted by the regulations; it would

subvert the operation of the source rules, and it would

lead to incongruous and erroneous results.

       We believe that petitioner misconstrues section 1.861-

8(e)(2)(i), Income Tax Regs., and finds an ambiguity where

none exists.    As discussed above, the rules of general
                           - 42 -

applicability for the allocation and apportionment of

expenses, losses, and other deductions, set forth in

section 1.861-8(a), (b), and (c), Income Tax Regs., are

based on the approach that an expense, loss, or other

deduction should be allocated to a class of income,

composed of less than the taxpayer's entire gross income,

as to which the deduction bears a factual relationship,

and then, if necessary, apportioned between or among the

statutory and residual groupings of gross income.   See sec.

1.861-8(a), (b), and (c), Income Tax Regs.   On the other

hand, the rules that specifically govern the allocation

and apportionment of interest expenses, with two limited

exceptions, take the approach that interest expenses are

related to all income-producing activities and properties

of the taxpayer and thus are allocable to all of the

taxpayer's gross income.   See sec. 1.861-8(e)(2)(i) and

(ii), Income Tax Regs.

     The regulations state that the different approach

for allocating interest expenses is based on the fact

that "money is fungible and that interest expense is

attributable to all activities and property regardless of

any specific purpose for incurring an obligation on which

interest is paid."   Sec. 1.861-8(e)(2)(i), Income Tax Regs.

Thus, the regulations use the phrase "money is fungible"
                             - 43 -

in section 1.861-8(e)(2)(i), Income Tax Regs., simply to

explain why the rules specifically dealing with interest

expenses allocate interest expenses to all of the

taxpayer's gross income, whereas the rules of general

applicability treat other deductions as related to one

or more classes of income.

     In order to facilitate our discussion of the

positions of the parties, it is helpful to review the

following example.   Assume that during the year a taxpayer,

a domestic corporation, had gross operating income from

domestic sales of $800,000, gross operating income from

foreign sales of $500,000, operating expenses of $300,000

attributable to domestic sales, and operating expenses of

$200,000 attributable to foreign sales.   Assume further

that, during the same year, the taxpayer realized interest

income from U.S. sources of $200,000 and interest expense

of $375,000.   Finally, assume that the ratio of the value

of the assets which relate to activities and properties

that generate foreign source income to the value of all

of the taxpayer's assets is the same as the ratio of the

taxpayer's gross income from foreign sources to total gross

income.   Based upon these facts, the computation of the

taxpayer's taxable income from U.S. and foreign sources,

assuming that netting is not permitted, and the proportion
                             - 44 -

of each to the taxpayer's entire taxable income, as

contemplated by section 904(a), are shown in the following

schedule:

    No netting           Total        U.S. source   Foreign source
Gross income
  Operating income     $1,300,000      $800,000       $500,000
  Interest income         200,000       200,000          -0-

    Total              1,500,000      1,000,000        500,000
Gross income ratio          100%         66.67%         33.33%

Expenses
 Operating expenses      500,000        300,000        200,000
 Interest expense        375,000        250,000        125,000
   Total                 875,000        550,000        325,000

Taxable income           625,000        450,000        175,000

Section 904(a) ratio        100%            72%            28%



     Petitioner's position, is that section 1.861-8(e)(2)

(i), Income Tax Regs., permits a taxpayer to offset

interest expense with interest income before "net interest

expense" is allocated and apportioned under section 1.861-

8(e)(2), Income Tax Regs., to the different groupings of

gross income for purposes of computing the taxpayer's

taxable income in each grouping.      Based on petitioner's

position, the computation of the taxpayer's taxable income

from U.S. and foreign sources, and the proportion of each

to the taxpayer's entire taxable income as contemplated by

section 904(a), are shown in the following schedule:
                             - 45 -
    With netting         Total        U.S. source   Foreign source
Gross income
  Operating income     $1,300,000      $800,000       $500,000
  Interest income          -0-            -0-            -0-
    Total               1,300,000       800,000        500,000
Gross income ratio           100%        61.54%         38.46%

Expenses
 Operating expenses      500,000        300,000        200,000
 Interest expense        175,000        107,692         67,308
   Total                 675,000        407,692        267,308

Taxable income           625,000        392,308        232,692

Sec. 904(a) ratio           100%       62.7692%       37.2308%


Thus, in this example, the netting of interest expense and

interest income has the effect of increasing, from 28

percent to 37.23 percent, the proportion of the taxpayer's

taxable income, $625,000, that is attributable to foreign

sources.

     There are several consequences of netting that should

be noted.    First, in order for the netting computation to

arrive at the taxpayer's correct taxable income, i.e.,

$625,000 in the above example, the taxpayer's total gross

income must be reduced by the amount of interest income

that is offset against interest expense.       This adjustment

is necessary because only net interest expense is allocated

and apportioned to the statutory grouping (i.e., foreign

source) and the residual grouping (i.e., United States

source) under section 1.861-8(e)(2), Income Tax Regs.

Accordingly, the aggregate deductions used in the netting

computation are less than actual aggregate deductions.
                                    - 46 -

Thus, taxpayer's taxable income, i.e., the difference

between the gross income in both groupings and the

aggregate expenses allocated and apportioned thereto, will

be overstated, unless the taxpayer's total gross income is

reduced by the amount of interest income that was offset.

        Continuing the above example, if interest expense and

interest income are netted for purposes of allocating

interest expenses but the amount of interest income offset

by netting is not removed from the taxpayer's gross income,

then the computation contemplated by section 904(a) would

be as follows:

    With netting             Total           U.S. source    Foreign source
Gross income
  Operating income        $1,300,000          $800,000            $500,000
  Interest income            200,000           200,000               -0-
    Total                  1,500,000         1,000,000             500,000
Gross income ratio              100%            66.67%              33.33%

Expenses
 Operating expenses          500,000              300,000         200,000
 Interest expense            175,000              116,667          58,333
   Total                     675,000              416,667         258,333

Taxable income               825,000              583,333         241,667
                                1             1               1
Sec. 904(a) ratio                132%          93.3333%        38.6667%

    1
        Based upon taxable income of $625,000.


Thus, as illustrated above, if the taxpayer's gross income

is not reduced, then the taxpayer's taxable income,

$625,000, would be overstated by the amount of the interest

income that is offset by interest expense, $200,000, and

the section 904(a) ratio would not be based upon the
                            - 47 -

taxpayer's "entire taxable income for the same taxable

year".   Sec. 904(a).   This raises a question about where in

the regulations is there authority to reduce "gross income"

by the amount of netted interest.

     Second, an equally important consequence of netting is

the fact that it increases the ratio under section 904(a),

and thus increases the amount of foreign tax credit, only

to the extent that the interest income that is absorbed by

interest expense in the netting process is from U.S.

sources.   To the extent that a relatively greater amount of

the interest income absorbed in the netting process is from

foreign sources, then netting produces a lower ratio under

section 904(a) than not netting.

     In the above example, we assumed that all of the

interest income, $200,000, was from U.S. sources.   In that

case, the section 904(a) ratio computed without netting was

28 percent but was increased to 37.23 percent by netting.

On the other hand, if we assume that the interest income is

entirely from foreign sources, then the section 904(a)

ratio, without netting, is 52 percent, computed as follows:
                             - 48 -
    No netting           Total        U.S. source   Foreign source
Gross income
  Operating income     $1,300,000      $800,000       $500,000
  Interest income         200,000         -0-          200,000

    Total              1,500,000        800,000        700,000
Gross income ratio          100%         53.33%         46.67%

Expenses
 Operating expenses      500,000        300,000        200,000
 Interest expense        375,000        200,000        175,000

  Total                  875,000        500,000        375,000

Taxable income           625,000        300,000        325,000

Sec. 904(a) ratio           100%            48%            52%


If interest expense and interest income are netted,

however, the ratio is reduced to 37.23 percent.       Thus, even

though the taxpayer received all of his interest income

from foreign sources under the regulations dealing with

interest income, sec. 1.861-2, Income Tax Regs., netting

disregards the source of the interest income that is

absorbed by interest expenses and causes the taxpayer to

obtain the same foreign tax credit as another taxpayer who

realized interest income entirely from U.S. sources.        This

example demonstrates that the netting of interest expense

and interest income which petitioner argues arises from

section 1.861-8(e)(2)(i), Income Tax Regs., fails to take

into account the source of the interest income, and it

causes interest income from entirely different sources to

be treated the same.
                          - 49 -

     In our view, petitioner's position that it "may

allocate and apportion net, rather than gross, interest

expense under section 1.861-8(e)(2), Income Tax Regs." is

foreclosed by the language of that regulation.   Section

1.861-8(e)(2)(ii), Income Tax Regs., provides that "the

aggregate of deductions for interest" are allocable to

"all the gross income" of the taxpayer for the year.    As we

read it, section 1.861-8(e)(2)(ii), Income Tax Regs., thus

directs that the gross amount of the taxpayer's interest

deductions, i.e., the aggregate of deductions for interest,

be allocated to all of the taxpayer's gross income.    In

effect, section 1.861-8(e)(2)(ii), Income Tax Regs.,

forecloses petitioner's position that net interest expense,

i.e., less than "the aggregate of deduction for interest",

can be allocated to less than "all of the taxpayer's gross

income", i.e., the excess of the taxpayer's gross income

over the portion of the taxpayer's interest income that is

offset by interest expenses.

     Furthermore, petitioner's position that it "may

allocate and apportion net, rather than gross, interest

expense" is foreclosed by sections 861(a)(1), 862(a)(1),

and the regulations promulgated thereunder, including

sections 1.861-2(a) and 1.862-1(a), Income Tax Regs.    Those
                          - 50 -

provisions define "gross income from sources within the

United States" and "gross income from sources without the

United States" to include all of the interest income earned

by the taxpayer during the taxable year.   Secs. 1.861-2(a),

1.862-1(a), Income Tax Regs.   In computing gross income

from sources within and without the United States, neither

the statute nor the regulations contemplate that the

portion of the taxpayer's gross income consisting of

interest income for the year will be reduced or entirely

offset by interest expenses.

     As shown in the hypothetical example discussed above,

such a reduction of the amount of the taxpayer's gross

income would be necessary in a netting computation.

Otherwise, the computation would overstate the taxpayer's

taxable income for the year by the interest income that

is offset by interest expense.   The adjustment to gross

income that would be necessary is depicted in the

computation set forth in the hypothetical discussed above.

It is similar to the adjustment that the parties made in

computing the taxpayer's interest expense for 1986 as shown

in the appendix.

     Moreover, petitioner's position that it is entitled to

allocate net interest expense under section 1.861-8(e)(2),
                           - 51 -

Income Tax Regs., means that the taxpayer's interest

income, to the extent that it is offset by interest

expense, is not included in the groupings of gross income,

i.e. gross income from sources within and without the

United States, contrary to sections 861(a)(1) and

862(a)(1).   Sec. 861(a)(1).   Thus, in our view, interest

netting would subvert the operation of the source rules.

     Generally, as discussed above, the source rules

operate by assigning items of gross income to different

groupings of gross income, such as income from sources

within and without the United States, in accordance with

standards set out in the statute, and by allocating and

apportioning the taxpayer's expenses, losses, and other

deductions to the different groupings.    Items of gross

income that constitute interest are assigned to groupings

of gross income from sources within and without the United

States generally in accordance with the residence of the

payor.   See sec. 1.861-2, Income Tax Regs.

     Under interest netting, interest income is offset by

interest expense and only net interest expense is allocated

and apportioned under the source rules.    In effect, the

source of the interest income that is offset is not taken

into account in the groupings of gross income and taxable
                           - 52 -

income, as contemplated under the source rules.   Netting

would, thus, subvert the operation of those rules.

     Netting would also lead to the incongruous and

erroneous results depicted in the hypothetical example

discussed above in which a taxpayer who realized interest

income entirely from foreign sources is treated the same as

a taxpayer who realized the same interest income entirely

from United States sources.   As discussed above, to the

extent that a relatively greater amount of interest income

absorbed in the netting process is from foreign sources,

then netting actually produces a lower taxable income from

foreign sources than not netting.

     As mentioned above, the issue in this case was first

decided in connection with the 1977 Regulations, in

Bowater, Inc., & Subs. v. Commissioner, 

(1993).   In light of the opinion of the U.S. Court of

Appeals for the Second Circuit reversing our opinion in

Bowater, Inc., it is appropriate to reconsider our Bowater,

Inc. opinion.   It is also appropriate to reconsider

Bowater, Inc., in light of the opinion of the U.S. Court

of Appeals for the Fifth Circuit in Dresser Indus., Inc.

v. United States, 

(5th Cir. 2001), in which

that court holds that interest netting is not permitted
                           - 53 -

under section 1.861-8(e)(2), Income Tax Regs.   In this

connection, we note that our opinion in Bowater, Inc.,

in part, had relied upon the reasoning of a prior opinion

of the U.S. Court of Appeals for the Fifth Circuit

involving the predecessor of the 1977 regulation, Dresser

Indus., Inc. v. Commissioner, 

(5th Cir.

1990), revg. 

(1989).   Following our

reconsideration of this issue, we now agree with both the

U.S. Courts of Appeals for the Second and Fifth Circuits

that the subject regulation, section 1.861-8(e)(2), Income

Tax Regs., does not permit the netting of interest income

and interest expense.   In light of that, we hereby overrule

our opinion in Bowater, Inc., & Subs. v. Commissioner, 

(1993).

     For reasons set forth above,

                               An appropriate order will be

                               issued granting respondent’s

                               motion in limine.

     Reviewed by the Court.

     SWIFT, GERBER, RUWE, COLVIN, HALPERN, BEGHE, CHIECHI,
LARO, FOLEY, VASQUEZ, GALE, and MARVEL, JJ., agree with
this opinion.

     WELLS and THORNTON, JJ., did not participate in the
consideration of this opinion.
                                      - 54 -

                                       Appendix



1982                     Interest     Net interest   Asset ratio    Interest apportioned to foreign
                         expense        expense        percent              source income
                                                                     No netting              Netting
650 Leasing Co.           $682,931       -0-          34.34          $234,519          -0-

Sun Leasing Co.          4,729,086   $3,216,310       64.81         3,064,921      $2,084,491

666 Leasing Co.          4,072,539    2,167,684       64.98         2,646,336       1,408,561

670 Leasing Co.          1,830,136       89,166       69.96         1,280,363          62,381

673 Leasing Co.          1,627,381      374,085       55.98           911,008         209,413

675 Leasing Co.          1,983,276    1,146,615       60.65         1,202,857         695,422

652 Leasing Co.            794,330       -0-          73.42           583,197          -0-

Kee Leasing Co.            581,235      567,862       44.47           258,475         252,528

653 Leasing Co.            814,727       -0-          89.11           726,003          -0-

667 Leasing Co.          3,286,585      647,476       80.00         2,629,268         517,981

Millcreek Leasing Co.      830,407       -0-           4.26            35,375          -0-

De Sun Shipping             47,658       -0-           0.58                  276       -0-

Eastern Sun Shipping        37,115       -0-           0.51                  189       -0-

NY Sun Shipping          9,970,340    9,116,332       90.23         8,996,238       8,225,666

NJ Sun Shipping            143,340      127,135        3.76             5,390           4,780

PA Shipping                 46,423       -0-           2.70             1,253          -0-

Phil Sun Shipping       10,809,958   10,361,281       29.54         3,193,262       3,060,722

Western Sun Shipping        50,003       -0-           0.00            -0-             -0-

Sun Transport, Inc.      3,650,045    3,550,205       25.99           948,647         922,698

Sun Note Co.            31,066,253       -0-          91.39        28,391,449          -0-

North Sea Oil Co.           65,897       -0-          34.77            22,912          -0-

Totem Ocean Trailer         46,949       -0-          49.39            23,188          -0-

  Total                 77,166,614   31,364,151                    55,155,126      17,444,643
                                       - 55 -



1983                       Interest   Net interest   Asset ratio     Interest apportioned to foreign
                           expense      expense        percent                source income
                                                                     No Netting        Netting
 650 Leasing Co.           $612,220      -0-           27.22         $166,646          -0-

 Sun Leasing Co.          4,736,241   $3,154,840       63.17        2,991,883      $1,992,912

 666 Leasing Co.          4,084,197    2,376,712       53.36        2,179,328       1,268,214

 670 Leasing Co.          1,756,214      617,207       71.74        1,259,908         442,784

 672 Leasing Co.            714,282       82,784       57.18          408,426          47,336

 Kee Leasing Co.            504,412      497,647       43.41          218,965         216,029

 653 Leasing Co.            736,315       77,583       67.56          497,454          52,415

 667 Leasing Co.          3,160,356    1,670,995       83.00        2,623,095       1,386,926

 Millcreek Leasing Co.      742,214      -0-            5.85           43,420          -0-

 NY Sun Shipping          9,849,306    9,122,147       83.33        8,207,427       7,601,485

 NJ Sun Shipping Co.        208,102      -0-            1.97            4,100          -0-

 Phil Sun Shipping       10,688,995    9,833,854       29.29        3,130,807       2,880,336

 Texas Sun Shipping          33,963      -0-            4.56            1,549          -0-

 Tropic Sun Shipping        474,700      -0-           27.47          130,400          -0-

 Sun Transport, Inc.      2,644,781    1,664,584       20.58          544,296         342,571

 Heleasco Fifteen         1,444,639    1,197,778       80.91        1,168,857         969,122

 Sun Note Co.            25,667,812      -0-           92.67       23,786,361          -0-

  Total                  68,058,749   30,296,131                   47,362,922       17,200,130
                                                - 56 -


    1984               Interest       Net interest   Asset ratio   Interest apportioned to foreign
                       expense           expense      percent             source income
                                                                   No netting       Netting
Kee Leasing Co.         $408,197        $397,659       17.77         $72,537          $70,664

666 Leasing Co.        4,083,327       1,874,164       33.48       1,367,098          627,470

670 Leasing Co.        1,669,360         299,856       48.22         804,965          144,591

650 Leasing Co.             536,038       -0-            6.90         36,987            -0-

652 Leasing Co.             613,066       -0-          38.08         233,456            -0-

653 Leasing Co.             636,635       -0-          25.12         159,923            -0-

667 Leasing Co.        3,018,359       1,406,484       37.98       1,146,373          534,183

Sun Leasing Co.        4,689,864       2,645,034       44.68       2,095,431        1,181,801

NY Sun Shipping        9,712,823       9,180,293       86.91       8,441,414        7,978,593

Phil Sun Shipping     10,551,646       9,875,526       35.37       3,732,117        3,492,974

Tropic Sun Shipping         644,883       -0-          12.02          77,515            -0-

Sun Transport, Inc.    3,091,754       3,056,531       16.87         521,579          515,637
                        1
Sun Oil Trading Co.      627,633          -0-            0.00           -0-             -0-

Sun Note Co.          25,854,099          -0-          93.06       24,059,825           -0-

North Sea Sun Oil
Co.                    7,681,288       5,485,009       96.36        7,401,689       5,285,355

 Total                73,818,972      34,220,556                   50,150,909      19,831,268


1
    See p. 9, supra
                                                                           - 57 -

1986 No netting                                                                                        Gross
                                                     Asset                                             income
                            Gross                    ratio      Interest                               ratio         §1.861-8(e)     §1.861-8(e)    §1.861-8(e)    Interest
                                                                                                                 2
                           income       Foreign GI   percent    expense                                percent       (2)(vi)(A)      (2)(vi)(B)(1) (2)(vi)(B)(2) apportioned

Kee Leasing Co.           $2,013,346     $260,455     4.71        $213,410                               12.94            $27,608     -              -                    $27,608
666 Leasing Co.            7,082,756    3,172,987    18.63       3,907,731                               44.80           1,750,615    -              -                    1750,615
670 Leasing Co.            3,533,401    1,496,424    42.66       1,468,580                               42.35            621,956     -              -                    621,956
650 Leasing Co.            2,038,955      954,294     0.00         404,732                               46.80            189,427     -              -                    189,427
Sun Leasing Co.            6,194,365    2,679,882     0.00       4,532,004                               43.26           1,960,691    -              -                1,960,691
Millcreek
                            1
 Leasing Co.                 305,752      -83,676     0.53         435,448                                0.00       -                        $1,154 -                      1,154
Tropic Sun Shipping        3,986,919    1,501,298     2.73         644,829                               37.66             242,814    -              -                    242,814
Sun Transport, Inc.       79,520,790    21,932,881   20.91       2,356,829                               27.58            650,044     -              -                    650,044
Sunoco
 Overseas, Inc.             -108,199      290,314     0.00         211,438                              100.00       -                -                   $105,719        105,719
Sun Refining &
Marketing Co.            672,597,605    1,095,517    20.27      44,588,973                                0.16       -                    4,519,092 -                 4,519,092
Sun Oil
 Trading Co.              13,481,454    4,673,000     0.00         549,406                               34.66            190,437     -              -                    190,437
                                                                                                                                          3                           3
Sun Co., Inc.            760,884,991    23,864,572    6.47     157,687,537                                3.14       -                    5,097,676 -                 5,097,676
Sun Oil Intl.             19,593,916     6,769,393   34.60       7,190,703                               34.55           2,484,276    -              -                2,484,276
North Sea
 Sun Oil Co.               36,565,327   36,394,917   97.00      28,050,064                               99.53       -                -                  27,629,313   27,629,313
Claymont Investment
Co.                       513,112,873      111,203    0.00     217,180,793                                0.02             47,068     -              -                     47,068
 Total                  2,120,804,251 105,113,461              469,422,477                                                                                            45,517,890


     1
         Cannot reconcile this amount with the fact that this corporation realized interest income of $646,275 during 1986.
     2
         Foreign source gross income divided by total gross income.
     3
         It appears that this amount should be $5,101,192 (i.e., $157,687,537 x 6.47 percent x 50 percent).
                                                                       - 58 -


1986 Netting                                                                                              Gross
                                                     Asset                                                income
                                                     ratio     Interest      Interest                    ratio     §1.861-8(e) §1.861-8(e)   §1.861-8(e)             Interest
                      Gross income    Foreign GI    percent    expense        income      Net interest    percent4 (2)(vi)(A) (2)(vi)(B)(1) (2)(vi)(B)(2)           apportioned

Kee Leasing Co.          $2,013,346     $260,455      4.71      $213,410        $9,844        $203,566        13.00          $26,464   -               -                    $26,464
666 Leasing Co.           7,082,756    3,172,987     18.63     3,907,731       736,783       3,170,948        50.00      1,585,474     -               -                1,585,474
670 Leasing Co.           3,533,401    1,496,424     42.66     1,468,580       540,553         928,027        50.00          464,014   -               -                    464,014
650 Leasing Co.           2,038,955      954,294      0.00       404,732       130,367         274,365        50.00          137,183   -               -                    137,183
Sun Leasing Co.           6,194,365    2,679,882      0.00     4,532,004       834,601       3,697,403        50.00      1,848,702     -               -                1,848,702
Millcreek                                                                                                                              -
                            1
 Leasing Co.                305,752      -83,676      0.53       435,448       662,752         -0-                0.00        -0-                      -                      -0-
Tropic Sun Shipping       3,986,919    1,501,298      2.73       644,829     1,148,919         -0-            44.92           -0-      -               -                     -0-
Sun Transport, Inc.      79,520,790   21,932,881     20.91     2,356,829       646,275       1,710,554        27.81          475,659   -               -                    475,659
Sunoco
 Overseas, Inc.            -108,199      290,314      0.00       211,438       189,663          21,775    100.00         -             -                      10,888        10,888
Sun Refining &
                                                                                                              5
Marketing Co.           672,597,605    1,095,517     20.27    44,588,973    23,675,379      20,913,594            0.14   -                 2,119,593   -                2,119,593
Sun Oil
 Trading Co.             13,481,454    4,673,000      0.00       549,406       317,610         231,796        35.50          82,285 -                  -                    82,285
                                                                                                                                           6                            6
Sun Company Inc.        760,884,991   23,864,572      6.47    157,687,537      937,176     156,750,361            3.14   -                 5,067,379   -                5,067,379
Sun Oil Intl.            19,593,916    6,769,393     34.60     7,190,703    12,824,523         -0-            54.58           -0-      -               -                     -0-
North Sea
                                                                                                          7
 Sun Oil Co.             36,565,327   36,394,917     97.00    28,050,064     1,784,106      26,265,958        99.51      -             -                   25,871,969   25,871,969
Claymont Investment
Co.                     513,112,873      111,203      0.00    217,180,793   505,319,941        -0-                0.04        -0-      -               -                     -0-
  Total               2,120,804,251   105,113,461             469,422,477   549,758,492    214,168,347                                                                  37,689,970


     1
       Cannot reconcile this amount with the fact that this corporation realized interest income of $646,275 during 1986.
     4
       Foreign source gross income divided by the excess of total gross income over interest income.
     5
       It appears that this percentage should be 0.17 percent (i.e., $1,095,517 ÷ ($672,597,605 - $23,675,379)).
     6
       It appears that this amount should be $5,070,874 (i.e., $156,750,361 x 6.47 percent x 50 percent).
     7
       Interest income treated as foreign source income. Thus in computing the allocation ratio, 99.51 percent, interest income is removed from both the numerator and the
denominator of the fraction (($36,394,917 - $1,784,106) ÷ ($36,565,327 - $1,784,106)).