*160 Decision will be entered under Rule 50.
1. The limit of the credit for foreign taxes allowable under section 131, Revenue Acts of 1936 and 1938, being based, under subsection (b), upon a ratio of net income from foreign sources to entire net income, held foreign income must be reduced by identifiable expenses, losses, or other deductions, and a ratable proportion of unallocable expenses, as provided in section 119, although the foreign tax was withheld at source and allegedly imposed upon the foreign income or items thereof without deduction of any expenses, losses, or other allowable deductions applicable thereto.
2. Royalties paid by petitioner to domestic corporations for use of patents made available to its foreign subsidiaries are ratably allocable against income from foreign sources, since such royalties are an inherent incident of the income received by petitioner from its foreign subsidiaries.
3. Declared value excess profits tax allowable as a deduction under section 23 (c), Revenue Act of 1938, to no extent reduces income from sources without the United States, but only income from sources within the United States, since it is a tax upon doing business and not upon*161 income.
4. British income taxes withheld from patent royalties accruable to petitioner from its British subsidiary are not allowable as a credit under section 131, Revenue Act of 1936. Trico Products Corporation, 46 B. T. A. 346, and Irving Air Chute Co., 1 T. C. 880, followed.
*1153 The Commissioner determined deficiencies of $ 58,989.50 in income tax for 1937 and $ 231,529.47 in income tax and $ 20,607.92 in excess profits tax for 1938.
The principal issue is with regard to the credit for foreign taxes under section 131 of the Revenue Acts of 1936 and 1938. This includes (1) the determination of the meaning in subsection (b) of the term "net income," (2) whether royalties paid to domestic corporations in 1937, and excess profits taxes for 1938, are deductible in full from gross income from sources within the United States or to a ratable extent from foreign sources, and (3) whether British taxes on patent royalties paid to petitioner by its British subsidiary in*162 1937 are, as to petitioner, "taxes paid or accrued."
FINDINGS OF FACT.
The petitioner is a Delaware corporation, with its office at 67 Broad Street, New York, New York. Its returns for 1937 and 1938 were filed in the second district of New York, and in them it signified its desire to have the benefits of section 131. Its books of account and returns were on an accrual basis.
*1154 The petitioner, organized in 1918, is an intermediate holding and management company in the International Telephone & Telegraph System, a world-wide system of telephone, telegraph, and radio communication, with sales and manufacturing units. Most of the foreign sales and manufacturing units were, in the taxable years, under the ownership of petitioner, whose stock was all owned by the International Telephone & Telegraph Corporation. Each of the subsidiaries, with the exception of one domestic corporation operating in China, was incorporated under the laws of the country in which it operates. They do not engage in business within and have no offices in the United States. On the balance sheets as of December 31, 1937 and 1938, attached to the returns of petitioner, are investments of $ 29,459,411.54*163 and $ 43,648,354.97, respectively, in stocks and bonds of foreign corporations.
1. The petitioner is not engaged in manufacturing, does not do business in any foreign country, and has no foreign branch or office. Under written contracts with its foreign subsidiaries, it provides management services, technical assistance, and patent, financial, and accounting information. In its New York offices it employs experts, technicians, and clerks, who are informed about developments in the communications industry and correlate the work of the laboratories and the manufacturing and sales subsidiaries located abroad. Technical experts on petitioner's staff are loaned to subsidiaries at the latter's expense. For its managing services petitioner charges its subsidiaries fees, usually computed on a percentage of sales basis, and it charges for patent privileges, royalties, and patent information.
Gross income as shown on the income tax returns for 1937 and 1938 is as follows:
| 1937 | 1938 | |
| Gross profit from sales | $ 1,152,963.05 | $ 1,082,320.62 |
| Royalties | 967,227.24 | 927,856.48 |
| Contract revenue | 381,343.23 | 507,550.24 |
| Dividends from stocks of foreign corporations | 3,764,682.81 | 5,609,585.47 |
| Interest earned | 290,427.64 | 364,624.96 |
| Interest on obligations of the United States | 425.00 | 425.00 |
| Commissions | 20,748.25 | 14,299.33 |
| Capital gain or (loss) | 83,589.61 | (2,000.00) |
| Miscellaneous income | 108,416.69 | 143,045.99 |
| Profit realized on foreign exchange | 95,501.91 | |
| Total | 6,769,823.52 | 8,743,210.00 |
*164 Allocation of gross income, as adjusted by the Commissioner, is as follows:
| 1937 | 1938 | |
| Sources within the United States | $ 207,695.70 | $ 146,548.40 |
| Sources without the United States | 6,416,729.16 | 9,049,300.62 |
| Total | 6,624,424.86 | 9,195,849.02 |
*1155 Gross income from sources within the United States consists of the following:
| 1937 | 1938 | |
| Royalties | $ 185.63 | |
| Interest | $ 194,317.69 | 133,023.71 |
| Interest on United States obligations | 425.00 | 425.00 |
| Commissions | 6,700.29 | 2,734.82 |
| Capital gain or (loss) | 24.17 | (2,000.00) |
| Miscellaneous income | 6,228.55 | 12,179.24 |
| Total | 207,695.70 | 146,548.40 |
In computing the limit on credit for foreign taxes allowable to petitioner for 1938, the Commissioner reduced gross income from United States sources by $ 2,000 capital loss. It is stipulated that this amount should be restored and that a corresponding amount should be allowed as a deduction.
Deductions as shown on income tax returns for 1937 and 1938 are as follows:
| 1937 | 1938 | |
| General and miscellaneous expense | $ 1,035,847.30 | $ 1,025,177.97 |
| Pension, sick and death benefits paid | 122,964.58 | 80,488.30 |
| Taxes, other than income taxes | 79,148.93 | 77,523.02 |
| Royalties, etc | 861,360.27 | 930,848.19 |
| Depreciation | 2,803.46 | 1,052.46 |
| Bad debts | 557.19 | 10,946.54 |
| Loss realized on foreign exchange | 164,994.02 | |
| Interest on funded debt | 275,848.30 | |
| Interest on unfunded debt | 337,745.34 | 404,732.85 |
| Amortization of patents | 588.17 | 1,448.92 |
| Amortization of bond discount and expense | 44,317.13 | |
| Total | 2,606,009.26 | 2,852,383.68 |
*165 Deductions for 1937 were reduced by respondent to $ 2,051,183.11, of which $ 262,533.71, including royalties of $ 154,698.33, was applied directly against gross income from foreign countries and $ 379,092.18, including royalties of $ 306,661.94, directly against United States gross income. Respondent reduced royalties from $ 861,360.27 to $ 461,360.27. Of the deductions for 1938, $ 2,761,412.74, including royalties of $ 930,848.19, was treated as not directly allocable and $ 90,970.94 was applied directly against gross income from foreign countries and the United States.
The expenses were for the most part annually recurring operating expenses and the amounts remained fairly constant from year to year except for minor variations such as salary adjustments, etc. The amount of dividends from foreign subsidiaries varied, but the other gross income was fairly constant, as follows:
| 1937 | 1938 | |
| Gross income as reported | $ 6,769,823.52 | $ 8,743,210.00 |
| Foreign dividends | 3,764,682.81 | 5,609,585.47 |
| Gross income exclusive of foreign dividends | 3,005,140.71 | 3,133,624.53 |
| Expenses deducted | 2,606,009.26 | 2,852,383.68 |
*1156 The petitioner has owned the shares of most of its subsidiaries*166 for many years, and does not buy and sell such shares.
The amount of expenses is not related to the amount of dividends from foreign subsidiaries. Such dividends did not reflect earnings for the year in which paid. The petitioner controlled the amount of dividends distributed to it by its subsidiaries.
Foreign taxes were withheld at source, except in Sweden and Australia, where, pursuant to local law, the payors of the income filed returns on behalf of the petitioner instead of withholding the tax.
2. The petitioner had a contract with the Western Electric Co., a domestic corporation, dated October 1, 1925, which provided for an exchange of patents and technical information and appointed petitioner as exclusive distributor for a term of fifteen years for the sale by it and its associate and allied companies of certain apparatus and merchandise in countries other than the United States, Canada, and Newfoundland in consideration of a fee or royalty based upon the sale of certain apparatus or equipment. It also had a contract with the Arcturus Co., a domestic corporation, relating to the manufacture and sale of radio tubes by petitioner's subsidiaries. The patent rights and technical*167 information under these contracts were made available to petitioner's foreign subsidiaries under contracts with them, as a result of which petitioner received royalties, contract revenue, and income from export sales.
During 1937 the royalties or fees paid or accrued by petitioner under such contracts were as follows:
| Western Electric Co | $ 293,568.14 |
| Arcturus Co | 13,093.80 |
| Total | 306,661.94 |
This $ 306,661.94 can not definitely be allocated to any item or class of gross income. In 1937 the respondent allowed the royalties paid in certain foreign countries as a deduction against the gross income from the foreign country in which paid.
In 1938 the total amount of royalties paid or accrued was $ 930,848.19, which was apportioned by the Commissioner on the basis of gross income from sources within each foreign country to total gross income. Respondent conceded at the hearing that royalties paid direct to foreign countries in 1938 should be segregated, allowed as a direct deduction against gross income of the foreign country in which paid, and to that extent taken out of the amount apportioned.
3. The petitioner's return for 1938 showed no excess profits tax liability. *168 The respondent determined a deficiency of $ 20,607.92 in excess profits tax for 1938. In computing the credit for foreign taxes the Commissioner inadvertently failed to deduct the amount of such tax from gross income from any source.
*1157 4. The petitioner granted its British subsidiary, Standard Telephones & Cables, Ltd., a license to use certain patents. The subsidiary in turn granted sublicenses to others. At the end of each quarter the petitioner was credited with one-half of the royalties received by its subsidiary, after the deduction of British income taxes and expenses of collection of or for handling the royalties received by the subsidiary. The royalties received by petitioner, and one-half of the British tax on the gross royalties received by the subsidiary are as follows:
| Amount | One-half | ||
| Year | due to | British | Total |
| petitioner | tax | ||
| 1937 | $ 108,494.69 | $ 40,925.38 | $ 149,420.07 |
| 1938 | 158,899.81 | 55,210.49 | 214,110.30 |
In its returns for 1937 and 1938, the petitioner reported $ 149,420.07 and $ 214,110.30, respectively, as royalty income derived from its British subsidiary, and took credits for foreign taxes of $ 40,925.38 and $ 55,210.49, respectively.
*169 OPINION.
1. The petitioner is a domestic corporation which in 1937 and 1938 had income from numerous foreign countries. By section 131 of the Revenue Acts of 1936 and 1938, it was entitled to credit for the income taxes paid or accrued to such foreign countries, but such credit was, by subsection (b), limited to a proportionate amount of such foreign income tax. The amount of the credit was expressly fixed as in the same ratio to the taxpayer's total United States tax as the ratio of the taxpayer's foreign net income to its entire net income from all sources. The statutory factors of the given ratio are both stated as net income. The taxpayer proposes that the term net income be read with a different meaning in respect of ordinary, general, or operating income from the meaning in respect of income upon which the tax of the foreign country is collected by a withholding method -- such income as dividends, interest, royalties, and profits from sales, which, for want of a better term, we shall call "withholding-tax income." This is said to be based upon a necessary distinction between the operating income of foreign branches of a domestic corporation and the "withholding-tax income" *170 of a domestic corporation in order to avoid double taxation, which it is said would result and be contrary to the purpose of section 131. Cf. Burroughs Adding Machine Co. v. Terwilliger, 135 Fed. (2d) 608.
With the wisdom or desirability of such a proposal we have no concern, for that is a legislative problem and it is not the business of this Court to effectuate such a proposal unless it can be found to be within the fair and reasonable intendment of the statute in the terms *1158 in which it was enacted. The petitioner argues that no amount, actual or ratable, of its expenses or other deductions (which serve to reduce its entire gross income to become its entire net income, the large factor of its ratio) should be applied against its foreign "withholding-tax income," because the foreign taxes withheld at the source take no account of expenses or other deductions. It is argued that it would be artificial to reduce income by a part of general expenses since the "withholding-tax income" is derived without service or expense by petitioner. We can not regard this as an established fact, even though the petitioner's only witness so testified. *171 At most, the proposition is a matter of opinion, which the Court is not bound to adopt; and we should hesitate to say that a domestic corporation receiving income of various kinds from numerous foreign countries is wholly free from expense, say for rent, accounting, clerical, housekeeping, or otherwise, because the income comes to it after the foreign tax has been withheld.
But irrespective of the soundness of the proposition, there is no room for it in the statute. The ratio is that of foreign net income to entire net income. Both factors are stated in the same all-embracing term, as mathematically they would be in order that the ratio be of like quantities in the same class. The net income from all sources, domestic and foreign, takes account of all deductions, and the net income from foreign sources, for purpose of the ratio, is likewise the remainder after deductions. Section 119, imported by section 131 (e), provides that the unidentifiable amount of deductions applicable to foreign income is a ratable part of all unidentifiable deductions. This is a comparatively simple method of disposing of what might in many instances be an extremely difficult problem of accounting *172 with precision for the deductions applicable to a given part of a taxpayer's income. Indeed, the present taxpayer aptly illustrates the wisdom of avoiding any attempt to assign such deductions by other than a mathematical method. We hold that the Commissioner was correct in rejecting the theory that the foreign income factor of the ratio, even though it be "withholding-tax income," may not be reduced by deductions.
The petitioner argues that if it be held that any of its expenses are allocable to its foreign income, still no part may be allocated to its "withholding-tax income," particularly its dividends from foreign corporations. This is upon the proposition that such income is received without expense. What has already been said indicates that this contention can not be accepted. The statutory method of measuring the unallocable deductions by prorating them must be regarded as the intendment of the legislation with regard to all kinds of income, and there is no room for an exception in respect of dividends or other "withholding-tax income," as to which the method of collection of the tax is peculiar to the foreign country from which it is derived. As in the case of foreign*173 corporations deriving such income from sources *1159 within and without the United States, cf. Third Scottish American Trust Co., Ltd. v. United States, 37 Fed. Supp. 279, Congress has prescribed the substitution of the ratable portion of expenses for a difficult or inconvenient method of computing a more exact deduction. This provides for no exceptions in cases where the ratable amount seems at variance with the probable accurate expenses and other deductions. Since the foreign tax credit is within the legislative discretion, the prescribed method of computing it must be followed. The Commissioner's determination of the foreign tax credit is sustained.
2. The respondent pleads that in determining the deficiency he erred in treating the amount of royalties paid in the United States to domestic corporations as directly attributable entirely to United States income and not as part of the composite deduction against all income, domestic and foreign, of which a ratable part will be deductible in determining the net income from foreign sources. These domestic royalties, as shown by the evidence, are paid for the use of patents, and such patents*174 are permitted by petitioner to be used in foreign countries by its foreign affiliates. The royalties paid by petitioner are an inherent incident of the income received by petitioner from the foreign affiliates, and the expense, which apparently is not allocable to such income upon any more direct method, is properly to be included among those items which are apportionable and ratably assigned to income from foreign sources. The affirmative claim of the respondent is sustained. In 1937 the respondent also allowed the amount of royalties paid in certain foreign countries as a deduction against gross income of the foreign country in which paid. The petitioner on brief demands equal treatment by ratable apportionment in respect of these royalties. While this is in theory perhaps sound, the issue framed in the pleadings and the evidence does not contain the facts or figures upon which we can consider the question, and we therefore refrain from doing so.
3. Although the Commissioner determined, and petitioner does not contest, that petitioner is liable for a declared value excess profits tax of $ 20,607.92 for 1938, and respondent inadvertently failed to treat the amount as a deduction, *175 as he now concedes, petitioner demands that the deduction should be treated as entirely allocable to income from United States sources and to no extent as allocable, directly or ratably, to income from foreign sources in computing the foreign tax credit. In this contention, the petitioner is sustained. The excess profits tax is imposed by section 602 of the Revenue Act of 1938, and is among the taxes allowed as deductions in section 23 (c), the deductibility of which is saved by the parenthetical clause from the proscription generally applicable to excess profits taxes. Superheater Co. v. Commissioner, 125 Fed. (2d) 514. It is supplementary to the capital *1160 stock tax, and by section 602 (c) the provisions of the foreign tax credit section are expressly made inapplicable. While therefore the declared value excess profits tax is a deduction in computing taxable United States net income, it is not a factor in computing foreign net income. Since it is a prescribed factor of the taxable United States income, it can not be said to be among those items of United States and foreign income which can not definitely be allocated to either. It*176 is a tax upon doing business and not upon income, Superheater Co. v. Commissioner, supra.The respondent's treatment of it as a factor of apportionable deductions was incorrect.
4. Briefly, the petitioner contends that in computing its foreign tax credit in respect of taxes paid to the United Kingdom, they shall be computed to include the taxes withheld and paid at the source. The petitioner admits that the controversy is similar to that decided against the taxpayer in Trico Products Corporation, 46 B. T. A. 346, and to that pending decision in Irving Air Chute Co., Docket 96120. The latter case has now been decided, Irving Air Chute Co., 1 T. C. 880, denying the claimed credit upon the authority of Biddle v. Commissioner, 302 U.S. 573">302 U.S. 573, and following Trico Products Corporation, supra.We follow those decisions and sustain the Commissioner's determination. It should perhaps be added that petitioner has failed, as it frankly confessed at the trial, to complete the record as to evidence of the British law upon which *177 its contention necessarily rests; but since the cases cited both reject the theory presented, the matter of the sufficiency of evidence need not be discussed.
Several matters originally in controversy have been settled and effect will be given to the stipulated facts in the computation under Rule 50.
Decision will be entered under Rule 50.