October 24, 2009

Deere & Company v. Commissioner: Foreign Branch Income is Gross Receipts for Research Tax Credit

Houston Tax Attorney Blog

Houston Tax Attorney

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In Deere & Company v. Commissioner, 133 T.C. No. 11, the U.S. Tax Court concluded that income from foreign branches must be included in the gross receipts in computing the research tax credit.

Deere & Company (“Deere”) was in the business of manufacturing, distributing, and financing a full line of agricultural equipment, a variety of commercial and consumer equipment, and a broad range of equipment for construction and forestry and other products and provided various services to a worldwide market.

Deere was owned by a parent entity and the parent entity had branches in Germany, Italy, and Switzerland. Deere received income from the branches in Germany, Italy, and Switzerland. Deere included all of the income and all of the expenses from Deere’s operations through Deere’s German branch, Deere’s Italian branch, and Deere’s Swiss branch in computing its U.S. income tax liability.

Deere claimed a $5,978,898 research tax credit in 2001. Deere computed its research tax credit using the alternative incremental method, which factors in the average annual gross receipts (“AAGR”) for the prior four years. Deere computed its AAGRs using the total income that it reported on page 1, line 11, of its consolidated return for each of the prior four years less the following total of (a) gross receipts less returns and allowances and (b) other income items for each of those years from the operations that Deere conducted though Deere’s German branch, Deere’s Swiss branch, and Deere’s Italian branch (total annual gross receipts of Deere’s foreign branches).

The IRS disallowed the research tax credit as it concluded that Deere did not compute its AAGR correctly, as it should have included the income from its foreign branches for each of the four preceding tax years in AAGR.

The statute and regulations are not clear as to whether income from its foreign branches is to be included. Deere raised a number statutory construction and policy arguments in support of its position. The court did not agree with Deere’s arguments.

The court agreed with the IRS as a matter of law, concluding that Deere must include the income from its foreign branches for each of the four preceding tax years in AAGR.

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