811.512394 Shipping/38
The Department of State to the Japanese Embassy4
The views of the Japanese Government, as set forth in a memorandum transmitted with the Japanese Embassy’s note No. 158 of August 20, 1934,5 in regard to additional war profits tax asserted by the Treasury Department of the American Government against three Japanese shipping companies, namely, the Nippon Yusen Kaisha, the Osaka Shosen Kaisha, and the Toyo Kisen Kaisha, have received the careful consideration of the American Government.
[Page 952]The issues involve income tax liability for the years 1918 and 1919 of all three of the companies, and also for the year 1920 in the case of the Nippon Yusen Kaisha. All of the three taxable years involved are governed by the Revenue Act of 1918.6 That Act provided that in the case of a foreign corporation “gross income includes only the gross income from sources within the United States [Section 233 (b)]”.7 The Attorney General held, in an opinion rendered November 3, 1920 [32 Op. Atty. Gen. 336, 345], and published as a Treasury Decision [T. D. 3111], that in the case of a foreign steamship company “income from sources within the United States” means under this Act “income from freight and passenger traffic originating within the United States.”
The Revenue Act of 1921,8 which, of course, had no retroactive effect as to the years 1918, 1919 and 1920, contained detailed provisions as to the method of determining the “income from sources within the United States” of foreign corporations. Under this latter Act, “gains, profits and income from (1) transportation or other services rendered partly within and partly without the United States…9 shall be treated as derived partly from sources within and partly from sources without the United States” and “the portion of such net income attributable to sources within the United States may be determined by processes or formulas of general apportionment prescribed by the Commissioner (of Internal Revenue) with the approval of the Secretary (of the Treasury)”. In conformity with the authority granted under the portion above quoted of the Act, the Treasury Department on August 23, 1922, issued Treasury Decision 3387 which provided a detailed and somewhat involved formula for apportioning income as between sources within and sources without the United States.
This formula was much more favorable to the steamship companies as a group than the provisions of the Revenue Act of 1918 as interpreted by the Attorney General; and the representatives of the Japanese steamship companies and of other foreign steamship companies whose cases under the Revenue Act of 1918 had not been closed urgently insisted upon being given the benefit of the formula set out in Treasury Decision 3387. On January 21, 1924, the Attorney General reaffirmed his opinion of November 3, 1920, and expressed the view that the provisions of the Revenue Act of 1921 could not be applied retroactively to the Revenue Act of 1918. However, on July 1, 1927, the Treasury Department informed the Attorney General that the conclusions reached by him in these opinions had never been acquiesced in by the foreign steamship companies, and that the [Page 953] tax returns of a large number of steamship companies were then pending awaiting the determination by the courts of the proper method of computing tax liability for the years prior to 1921. On July 7, 1927, the Acting Attorney General rendered an opinion which recited the foregoing circumstances and the concluding paragraphs of which were as follows:
“The questions involved are difficult, and there is room for difference of opinion about them and the outcome of the litigation is doubtful, but the opinions referred to stand in the way of your dealing with these cases in the exercise of authority granted to you by law and in a way to serve the best interests of the United States. The questions do not arise under the Revenue Act for 1921 [42 Stat. 227], or any later Revenue Act.
“Under all the circumstances, you should be free to deal with the cases as the conditions seem to require, and, in order that you may do so, the opinions referred to are hereby withdrawn [Acting Attorney General to the Secretary of the Treasury—35 Op. Atty. Gen. 244].”
In computing the taxes to which exception is taken by the Japanese steamship companies, the formula prescribed by Treasury Decision 3387 was used. The application of this formula produces a much smaller aggregate tax than would result from application of the Revenue Act of 1918 as interpreted by the Attorney General, although under such interpretation no part of the Charter hire received by the Japanese steamship companies under the arrangement of 1918 between the American Government and the Japanese Government whereby Japanese vessels were placed at the disposal of the American Government, or subsidies received by the steamship companies from the Japanese Government, would be included as income. On the other hand the formula used in the computation of taxes requires the inclusion as one among many other factors of all income from services performed by vessels whose voyages include United States ports in the total amount to be allocated as “income from transportation and other services rendered partly within and partly without the United States”.
It is not possible to explain the formula in a few words, but it may be said that in effect it contemplates as one of its principal factors that the taxable income of a foreign vessel should bear that relation to the entire income derived from that vessel that the time spent by the vessel in American waters bears to the time occupied by it in making a round trip between the foreign terminal port and an American port of call.
It is obvious that a subsidy received by a foreign steamship company from a foreign government is not “income from sources within the United States”. However, the view of the Japanese Government that such subsidies “cannot be objects of taxation by the American [Page 954] Government” and that it is “unreasonable to consider the whole amount of the subsidies as taxable income, while they involve services in other parts of the world”, appears to be inconsistent with the previous insistence of the representatives of the Japanese steamship companies that the formula prescribed by Treasury Decision 3387 be used. Both the charter hire and the subsidy payments on the vessels engaged in commerce with the United States are deemed to be “income from transportation or other services rendered partly within and partly without the United States”, within the purview of the formula set out in Treasury Decision 3387. There would obviously be no occasion to use a formula to allocate income as between sources within and sources without the United States if there were excluded in the beginning all income other than “income from sources within the United States.”
It will be clear to the Japanese Government from a review of the foregoing circumstances that the application to the incomes of the Japanese steamship companies of the formula prescribed in Treasury Decision 3387 was no arbitrary act of the American Government. The fact is, on the contrary, that the formula was made applicable to incomes for the years 1918, 1919 and 1920 at the urgent insistence of the representatives of the foreign steamship companies, including the Japanese companies. The present insistence of the Japanese steamship companies upon the elimination of the items of charter hire and subsidy from a calculation of their income tax liability would seem to indicate their unwillingness to accept the burdens of the formula while enjoying its benefits.
Notwithstanding the fact that the issues relating to subsidies and charter hire would not have arisen had the Japanese steamship companies acquiesced in a settlement of their income tax liability on a basis consistent with the opinion rendered November 3, 1920, by the Attorney General, the American Government has given the most sympathetic attention to the circumstances, as they may affect the tax cases under discussion, arising out of the arrangement of 1918 by which the Japanese Government placed Japanese vessels at the disposal of the American Government. Accordingly, the Treasury Department has proposed to representatives of the Japanese steamship companies a settlement which contemplates a reduction of their income tax liability equivalent to the elimination both of the charter hire and of the subsidies from the formula used in determining taxable income. Such proposal of settlement, if accepted, would effect a reduction of the amount of the total deficiency payments from all three companies from approximately $2,300,000 to approximately $650,000.
As to the deductions for war amortization, there was at first doubt whether the Revenue Act of 1918 permitted war amortization for vessels built by a foreign corporation in a foreign country, but this [Page 955] doubt was resolved in favor of the foreign steamship companies in computing their proposed tax liability in these cases. No amortization was allowed, however, on any vessel which had not actually come into commerce with the United States on or before November 11, 1918. This rule was adopted after careful consideration of voluminous briefs filed by the steamship companies.
It has been the position of the taxation authorities of the American Government that the amortization provision of the Revenue Act of 1918 [Section 234 (a) (8)] does not contemplate amortization on vessels constructed after the Armistice except in special cases; for example, where a vessel was in process of construction on the date of the Armistice and its completion was required to carry out existing and uncancelled war contracts.
It is contended by the Japanese Government that amortization should be allowed on vessels built in Japan after the Armistice for the reasons that (1) such vessels were built to replace vessels placed at the disposal of the American Government and (2) a similar concession was made in regard to American vessels.
The suggestion that American vessels were granted the concession in regard to amortization of vessels built after the Armistice which has been denied to Japanese vessels is believed to be erroneous. It is true that in one case [U. S. v. Elliott, 16 Fed. (2d) 164] the District Court for the District of Maine allowed amortization on a small vessel the construction of which was not begun until after the Armistice, but the information available in that case discloses that the United States defended that case and that, pending appeal of the United States to the Circuit Court of Appeals, the case was settled on the basis of allowing amortization on only forty percent of the cost of the vessel, such forty percent being only that portion of the cost for which the taxpayer had become definitely obligated prior to the Armistice. The amount involved on this issue in the Elliott case was less than one thousand dollars.
With regard to the contention that amortization should be allowed on vessels built in Japan after the Armistice, for the reason that such vessels were built to replace vessels placed at the disposal of the American Government, there are disputed questions of fact. The American Government has no satisfactory evidence that any vessels were built by the Japanese steamship companies after the Armistice to replace vessels under charter to the United States, whereas it has received information to the effect that some or all of the Japanese steamship companies concerned sold vessels during the period of construction of the vessels on which amortization is claimed. There is further information to the effect that some of the vessels sold were disposed of at a large profit, no part of which profit has been included by the American tax authorities as taxable income.
[Page 956]The American Government has been mindful of the spirit of cooperation displayed in 1918 by the Japanese Government in placing Japanese vessels at the disposal of the American Government for the purpose of facilitating the united operations of the Allied and Associated Powers; and with a view to manifesting its sense of appreciation thereof, and to removing the basis of intervention by the Japanese Government in this controversy, the American Government is prepared to exempt the charter hire received by the Japanese steamship companies on account of such vessels from calculation of the income tax liability of such companies, and also to exempt the subsidies granted by the Japanese Government from such calculation; provided, however, that the Japanese steamship companies accept the determination of the Treasury Department with regard to the amortization issue and other minor questions involved in the cases. As previously indicated herein, the willingness of the American Government to make these concessions has been communicated to the Japanese steamship companies in the form of an offer to settle the cases on a basis which would reduce the amount of the aggregate deficiencies from approximately $2,300,000 (the amount now proposed) to approximately $650,000. The American Government does not, however, accept the contentions of the Japanese Government in regard to the amortization issue, which appears not to be related to any arrangement made between the American Government and the Japanese Government, but to be a matter lying entirely between the Japanese steamship companies, as taxpayers, and the taxation authorities of the American Government.
The American Government is unable to grant to the Japanese steamship companies a privileged position over and beyond that which would be granted in the same circumstances to American steamship companies in regard to an issue the relation of which to any arrangement made between the American Government and the Japanese Government has not been established.
The American Government has, however, presented substantial evidence of its attitude of responsiveness to the procedure initiated by the Japanese Government looking toward adjustment of the present controversy by friendly discussion between the two Governments concerned. The American Government is of the considered opinion that the proposal of settlement made by the taxation authorities to the representatives of the Japanese steamship companies is equitable and this Government commends that proposal to the careful consideration of the Japanese Government.
The Treasury Department is at the present time in position, by exercise of administrative discretion vested in it by law, to give weight to considerations favorable to the Japanese steamship companies which lie more in the field of equity than in the field of law. In the [Page 957] event that the proposal of settlement is rejected by the steamship companies and the cases are litigated, the Treasury Department expects to defend all issues, including both the charter hire and the subsidy issues, and it is probable that any decision rendered by the tribunal before which the cases might come to trial would be based primarily on the legal questions involved.
The cases under discussion are all pending before the Board of Tax Appeals, an independent tribunal created by Congress to hear and determine tax cases. The Japanese steamship companies may, of course, raise before the Board of Tax Appeals all of the points which are at issue, and if the decision there is adverse to them they may appeal to the courts.