*191 Judgment will be entered for the respondent.
Petitioner received patent royalties from its wholly owned subsidiary, an English company. The latter, on paying the royalties, withheld (as it was authorized but not required by British law to do) sums representing the amount of standard (normal) British tax thereon. A British income tax was levied upon, assessed against, and paid by the English company upon its profits and gains which, as required by British law, were computed without the allowance of a deduction for royalties paid. Held, petitioner is not entitled to a credit for taxes paid or accrued to a foreign country within the meaning of section 131 (a) (1) of the Revenue Act of 1934.
*880 The Commissioner issued a notice of deficiency advising petitioner of the determination of a deficiency in income tax for the year 1935 in the sum of $ 12,686.02 and of an overassessment in excess profits tax for the same year in the sum of $ 2,030.23. The only issue is whether the withholding of certain amounts at the*192 source from royalties paid to petitioner entitle it to a credit under section 131 (a) (1) of the Revenue Act of 1934 for income taxes paid or accrued to a foreign country.
*881 FINDINGS OF FACT.
Petitioner, a New York corporation, filed its return for 1935 upon the accrual basis with the collector for the twenty-eighth collection district of New York.
At all times material to this proceeding petitioner was the registered legal owner of certain British letters patent relating to airchutes and parachutes. Pursuant to an agreement entered into in 1926 between petitioner and an English company, the latter being petitioner's wholly owned subsidiary, petitioner granted the English company an exclusive license to manufacture and sell to the British Government airchutes and parachutes under said British letters patent in Great Britain and the British Dominions, excepting the Dominion of Canada. The consideration for the license was specified in the agreement to be the sum of fifteen thousand pounds and the payment by the English company to petitioner of a royalty of 10 percent "calculated on the total sale price of each and every Airchute sold by the English company." In 1933 by mutual*193 agreement, the royalty was increased from 10 percent to 12 percent.
During the calendar year 1935 the English company sold airchutes for an aggregate sales price of $ 946,218.33. (For simplicity all figures herein will be expressed in terms of American dollars.) Twelve percent of this amount is $ 113,546.20. During 1935 and thereafter the English company paid to petitioner, pursuant to its agreement, the amount of $ 87,998.32, after deduction pursuant to schedule D and general rule 19 (2) of the British Income Tax Act of 1918, as amended, of the sum of $ 25,547.88. The English company rendered petitioner an account of the royalties which had accrued to it during each month in 1935. Each account showed the total royalties at 12 percent, the amount withheld therefrom as tax, and the net royalties. The aggregate of the amounts shown on such accounts as gross royalties for the year 1935 was $ 113,546.20, and the aggregate of the net royalties, after deduction of sums representing taxes, was $ 87,998.32. At the end of each month in 1935 petitioner made a journal entry with respect to its royalties receivable, listing the net royalties which had accrued during the preceding month *194 and, as a separate item, "British tax paid at source." The total of these two items was entered under the heading of "Royalties Earned." The aggregate amounts shown by the journal entries coincided with the accounts furnished by the English company.
On January 8, 1937, pursuant to schedule D of the British Income Tax Act of 1918, the British Inland Revenue Collector for the Hitchin Collection District received from the English company taxes aggregating *882 $ 83,132.48 for the assessment year beginning April 6, 1936, and ending April 5, 1937, based upon amounts brought into charge to tax for the calendar year 1935. Rule 1 of the rules applicable to cases I and II of schedule D, Income Tax Act, 1918, provides that "The tax shall be charged without any other deduction than is by this Act allowed." Rule 3 (m) prescribes that in computing the amount of the profits or gains to be charged, "no sum shall be deducted in respect of * * * any royalty or other sum paid in respect of the user of a patent." In conformity with these provisions, the amounts brought into charge to tax by the English company were computed by taking the profit as shown on its profit and loss statement for the *195 year ending December 31, 1935, and by adding back thereto certain items that had been deducted on the books but which were not allowable as deductions in computing its taxable income. Among the items so added back was the amount of $ 113,546.20, the total royalties accrued to petitioner during the calendar year 1935.
On its Federal income tax return for the calendar year 1935 petitioner reported as income the full 12 percent royalty accruing to it in the amount of $ 113,546.20, though $ 25,547.88 of this amount was withheld from and never actually received by petitioner.
Attached to said return for 1935 was Form 1118 (Statement in Support of Credit Claimed on Corporation Income Tax Return for Taxes Paid or Accrued to a Foreign Country or a Possession of the United States). In said form petitioner claimed the sum of $ 25,547.88 as the amount of tax accrued and paid by it to Great Britain with respect to the royalty income. Of this amount petitioner claimed the sum of $ 25,347.53 as a credit against income tax due the United States for the year 1935, after application of the limitation upon the credit imposed by section 131 (b). In the notice of deficiency respondent denied petitioner's*196 claim for credit, and held that petitioner's reported income from royalties paid by the English company should be reduced to the net amount received, $ 87,998.32.
Income tax in Great Britain is charged by section 1 of the Income Tax Act, 1918, and the Finance Act of each particular year. The Finance Act of the year prescribes that income tax shall be charged for that year and at what rate the tax is to be charged. For the year commencing April 6, 1936, and ending April 5, 1937, relating to income for the year 1935, income tax in the United Kingdom was charged by section 14 (1) of the Finance Act, 1936, at the standard rate of four shillings and nine pence in the pound, in accordance with the schedules and rules of the Income Tax Act, 1918. The annual Finance Acts frequently amend the provisions of the Income Tax Act, 1918, in addition to imposing the rate of tax for the year. *883 Every Finance Act contains a provision that that part of the act which deals with income tax shall be construed as one with the Income Tax Acts, and that any reference in the Finance Act to any other enactment shall be construed as a reference to that enactment as amended by any subsequent enactment. *197 Thus the income tax law in force during the year ended April 5, 1937, was the Income Tax Act, 1918 (8 & , Ch. 40), as amended by all subsequent Finance Acts, including the Finance Act, 1936.
Section 1 of the basic 1918 Act provides that a tax charged by any income tax act shall be charged "in respect of all property, profits, or gains respectively described or comprised in the schedules marked A, B, C, D, and E, contained in the First Schedule to this Act and in accordance with the Rules respectively applicable to those Schedules." Sections 1 and 2 of schedule D of the United Kingdom Income Tax Act, 1918, provide, in material part, as follows:
1. Tax under this Schedule shall be charged in respect of --
(a) The annual profits or gains arising or accruing --
* * * *
(iii) to any person, whether a British subject or not, although not resident in the United Kingdom, from any property whatever in the United Kingdom, or from any trade, profession, employment, or vocation exercised within the United Kingdom; and
(b) All interest of money, annuities, and other annual profits or gains not charged under Schedule A, B, C or E and not specially exempted*198 from tax; in each case for every twenty shillings of the annual amount of the profits or gains.
2. Tax under this Schedule shall be charged under the following cases respectively; that is to say, --
Case I. -- Tax in respect of any trade not contained in any other Schedule;
* * * *
Case VI. -- Tax in respect of any annual profits or gains not falling under any of the foregoing Cases, and not charged by virtue of any other Schedule;
and subject to and in accordance with the rules applicable to the said Cases respectively.
The principle of deduction of tax at the source was introduced in Great Britain by the Income Tax Act, 1803, which provided that where annuities, interest of money, or other annual payments were charged upon any profits brought into charge under schedule D they were not to be allowed as deductions in computing the tax of the payor, but the latter was to recover a portion of the tax by deducting it on making the annual payment to the recipient. This principle was carried into the Act of 1842, which provided that, where such sums were payable out of profits or gains brought into charge to tax, no assessment was to be made upon the recipient *884 of such sums, *199 but the whole of the profits or gains was to be charged on the person liable to such annual payments and he was authorized to deduct out of such annual payment at the rate of tax imposed. The effect of these and kindred provisions was that if the payor had insufficient profits and gains to be taxable himself, he paid no tax, but at the same time he retained the amount he had withheld from the recipient without accountability therefor to the Crown. This situation was remedied by section 24 (3) of the Customs and Inland Revenue Act, 1888, by which it was made obligatory on any person paying interest or annuities, if they were not payable out of profits or gains brought into charge to tax, to deduct tax at the time of payment and to account to the Crown for the tax deducted.
The aforesaid provisions, however, did not apply to patent royalties, and until 1907 a person paying royalties was allowed to deduct them as an expense in computing the profits of his business; and the recipient of the royalties was taxed by direct assessment. This system as respects royalties was changed by section 25 of the Finance Act of 1907, which provided that in estimating the amount of profits and gains*200 arising from any trade no deduction should be made on account of royalties paid for the user of a patent. The section, however, authorized the person, upon paying the royalties, to deduct and retain thereout the amount of the rate of income tax chargeable thereon. Simultaneously, section 24 (3) of the Customs and Inland Revenue Act, 1888, was extended to cover royalties which were not paid out of profits or gains. The latter section, as noted above, made it obligatory upon the person paying interest or other annual sums to deduct and retain thereout the tax if the sum was not payable out of profits or gains brought into charge to tax.
In the enactment of the Income Tax Act, 1918, the portion of section 25 of the Finance Act, 1907, relating to disallowance of deduction for royalties in estimating the profits and gains of the payor became Rule 3 (m). The part of section 25 of the Finance Act, 1907, which authorized the payor to withhold and retain the tax on paying the royalties, became General Rule 19(2), which is stipulated to be the applicable provision in the instant case. Section 24 (3) of the Customs and Inland Revenue Act, 1888, making it obligatory to withhold the*201 tax if the royalties were not paid out of profits or gains, became General Rule 21 (1). The provisions for withholding of annuities, interest of money, or other annual payments, originating in 1803, and being carried into the 1842 Act, became Rule 19 (1). These various provisions in the 1918 Act are as follows:
*885 3. In computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of --
* * * *
(m) any royalty or other sum paid in respect of the user of a patent. * * *
19. -- (1) Where any yearly interest of money, annuity, or any other annual payment (whether payable within or out of the United Kingdom, either as a charge of any property of the person paying the same by virtue of any deed or will or otherwise, or as a reservation thereout, or as a personal debt or obligation by virtue of any contract, or whether payable half-yearly or at any shorter or more distant periods), is payable wholly out of profits or gains brought into charge to tax, no assessment shall be made upon the person entitled to such interest, annuity, or annual payment, but the whole of those profits or gains shall be assessed and charged with tax on the person liable*202 to the interest, annuity, or annual payment, without distinguishing the same, and the person liable to make such payment, whether out of the profits or gains charged with tax or out of any annual payment liable to deduction, or from which a deduction has been made, shall be entitled, on making such payment, to deduct and retain thereout a sum representing the amount of the tax thereon at the rate or rates of tax in force during the period through which the said payment was accruing due.
The person to whom such payment is made shall allow such deduction upon the receipt of the residue of the same, and the person making such deduction shall be acquitted and discharged of so much money as is represented by the deduction, as if that sum had been actually paid.
(2) Where any royalty, or other sum, is paid in respect of the user of a patent, wholly out of profits or gains brought into charge to tax, the person paying the royalty or sum shall be entitled, on making the payment, to deduct and retain thereout a sum representing the amount of the tax thereon at the rate or rates of tax in force during the period through which the royalty or sum was accruing due.
* * * *
21. -- (1) Upon payment*203 of any interest of money, annuity, or other annual payment charged with tax under Schedule D, or of any royalty or other sum paid in respect of the user of a patent, not payable, or not wholly payable out of profits or gains brought into charge, the person by or through whom any such payment is made shall deduct thereout a sum representing the amount of the tax thereon at the rate of tax in force at the time of the payment.
(2) Any such person shall forthwith render an account to the Commissioners of Inland Revenue of the amount so deducted, or of the amount deducted out of so much of the interest, annuity, annual payment, royalty, or other sum respectively, as is not paid out of profits or gains brought into charge, as the case may be, and every such amount shall be a debt from him to the Crown and shall be recoverable as such; and the provisions contained in section two of the Stamp Duties Management Act, 1891, in relation to money in the hands of any person for stamp duty, shall apply to money deducted by any such person in respect of tax.
In other words, where a royalty is paid under General Rule 21 (1) it is required that the paying company withhold a sum representing the amount*204 of tax thereon, which sum is to be accounted for by the paying company as a debt to the Crown and not as a taxpayer. *886 , and ; . Where the royalty is paid under General Rule 19 (2), the tax is assessed directly against the paying company as a taxpayer by the process of denying a deduction for the royalty paid; and the withholding of a sum representing the amount of tax thereon by the payor is optional with it, and when so withheld the sum becomes the property of the payor, who is not required to account to the Crown for the same. Thus, the difference between the two rules is that under Rule 21 the payor accounts to the revenue by paying over the specific amount of tax deducted, whereas under Rule 19 (2) the payor accounts to the revenue by the royalty being included in the assessment of his own income through his not being allowed to deduct it by reason of Rule 3 (m).
If the paying company failed to withhold, and if the profits and gains of the paying company happened to be nil, so that no tax was payable*205 by it, the Crown would be entitled to make an assessment under schedule D upon the recipient of the royalty. Wild v. Ionides (not reported), ; Constantinesco v. Rex (K. B. D.), 42 T. L. R. 383; (C. A.) 42 T. L. R. 685; and (H. L.) 43 T. L. R. 727; .
The right to withhold conferred by Rule 19 (2) is a right to deduct "on making the payment." Consequently, the right to withhold, if not exercised at the time the royalty is paid, is lost. There are exceptions to this rule where the payment is made prior to enactment of the Finance Act imposing the tax for the year, and where the rate of tax is increased after the payment has been made. In these circumstances the payor may deduct from the next payment, or if there is no next payment he may recover the sum which might have been deducted as if it were a debt due from the person against whom the deduction could originally have been made.
If a recipient of royalties from whom an amount has been withheld by the payor has a total income for the year in an amount less *206 than the income that is exempt from tax in Great Britain, the Crown will refund to him the amount withheld upon payment of the royalties. A refund will be made whether the withholding was under Rule 19 (2) or under Rule 21 (1). If the recipient of a royalty is an individual, he is required to include the gross royalty, including the amounts withheld, in computing his liability to surtax.
In the view of the United Kingdom law a recipient of patent royalties from whom there has been withheld a sum representing the amount of tax thereon is deemed to have paid a tax on such royalties by deduction.
*887 Under General Rule 22 1 the recipient of patent royalties has no right to be heard upon the determination of the assessment made upon the payor, but he has a right to be heard by the general commissioners if any dispute arises between the payor and himself with respect to the deduction on account of tax. The recipient of patent royalties has no opportunity of appealing from the commissioners to the High Court of Justice against an assessment because his tax normally is not collected by means of an assessment upon him, but by deduction.
*207 Withholding by the payor from amounts paid as copyright royalties to a nonresident of Great Britain is, by special statutory provisions, made under General Rule 21(1).
Under British law a dividend is not a taxable subject matter and a shareholder in a British company is not liable to normal tax with respect thereto. Neumann v. Commissioners of Inland Revenue (K. B.), 49 T. L. R. 1; (C. A.) [1933] 1 K. 13, 728, and (H. L.) [1934] A. C. 215; . If the tax appropriate to such dividend is deducted by the company, it does so for its own benefit and is not accountable therefor to the Crown. If a company should declare and pay a dividend without deducting tax, a shareholder would not be assessable for the tax appropriate to the dividend.
In the instant case the amount of $ 83,132.48 paid by the English company to the Crown was a tax levied upon, assessed against, and paid by the English company. Nothing less would have been accepted and no other person was liable to make the payment. , and (H. L.) 46 T. L. R. 349;*208 . The English company was not accountable to the Crown for the amount withheld from petitioner.
OPINION.
The sole question to be decided is whether, in the circumstances disclosed by the findings, petitioner is entitled to the *888 credit allowed by section 131 (a) (1) of the 1934 Act 2 for income taxes paid or accrued to a foreign country. Upon the record presented in (on appeal, C. C. A., 2d Cir.), we there held that a credit was not available to an American recipient of patent royalties from which amounts had been withheld under General Rule 19 (2) by a British licensee. In so holding we relied upon the decision of the Supreme Court in , a case involving dividends paid from British sources. Inasmuch as the question of foreign law is a matter of proof, the present petitioner contends that it is not precluded by the result reached in the Trico case and that upon the showing made in the present record a contrary decision is required. It was said in the Trico case, p. 383, that "we *209 have before us only 'The Income Tax Act, 1918' and statutory amendments thereto. We must accordingly consider that recourse to British case law and interpretation would be beyond the scope of this record * * *." In the case at bar there have been introduced the Income Tax Act, 1918, various Finance Acts for particular years, and the complete texts of numerous cases decided by the courts of Great Britain. In addition to these we have the benefit of a 100-page deposition upon written interrogatories and cross-interrogatories of Mr. John Stuart Scrimgeour, an English barrister-at-law who specializes in revenue matters.
*210 The question is not free from difficulty, but upon the whole record before us we are of opinion that the Commissioner correctly denied the credit.
An income tax was imposed upon the gains and profits of the British company under schedule D. The applicable rules provide that the tax shall be charged without any other deduction than is allowed by the act, and that in computing the amount of profits or gains to be charged no sum shall be deducted in respect of any royalty paid for the user of a patent. The British company accordingly paid tax upon its profits without the allowance of any deduction on account of royalties paid to petitioner. The tax was levied upon and assessed against the British company, was collected from it, and the remedies for nonpayment would have run against it. So far as concerns the present case this was the only tax received by the Crown. Petitioner insists that a portion of such tax was a tax paid by petitioner to a foreign country.
*889 General Rule 19 (2) prescribes that if a royalty is paid wholly out of taxable profits, as is true in the present case, the payor shall be entitled on paying the royalty to deduct thereout "a sum representing the*211 amount of the tax thereon." The British company in the instant case availed itself of the privilege thus granted by statute, and withheld $ 25,547.88 from the royalties payable to petitioner. This withholding, we are told, was the equivalent of the payment of a tax by petitioner. It should be observed, however, that the matter of withholding was entirely within the discretion of the English company. The amount of the latter's tax liability was exactly the same, whether it withheld from petitioner or not.
Whether petitioner is entitled to credit for foreign taxes paid "must ultimately be determined by ascertaining from an examination of the manner in which the British tax is laid and collected what the stockholder has done in conformity to British law and whether it is the substantial equivalent of payment of the tax as those terms are used in our own statute." It is not conclusive that the recipient of the royalty is regarded in the English law as having paid a tax by deduction. That he is so regarded is the view adopted by petitioner's expert witness, who took the position that the British company in paying the*212 amount assessed against it, paid a tax upon its own profits and at the same time accounted to the Crown for a tax due from petitioner which it had withheld. This is based upon the theory that royalties are an item of expense, rather than income, to the British company, and to the extent the British company's tax resulted from failure to allow a deduction of such expense the tax is not to be regarded as an income tax upon the British company, but rather upon the recipient of the royalty, as to whom the royalty constitutes income.
We think such a theory goes beyond the mere "manner in which the British tax is laid and collected," and finds no support in the statutory law or the cases introduced. So far as we are advised no case holds that in paying a tax levied upon it, a British company is at the same time accounting as an agent to the Crown for a tax withheld by it under General Rule 19 (2). 3 Indeed, the judgment of the House of Lords in , points in the other direction. In that case the taxpayer claimed relief from British income tax paid by it and the claim was resisted by the Crown*213 upon the ground that a portion of the tax had been passed on by the taxpayer by withholding an amount on the payment *890 of interest to its bondholders. The statute granted relief to a person "who has paid, by deduction or otherwise, United Kingdom income tax." The argument that the taxpayer had not paid the portion of the tax which had been passed on to the bondholders was rejected, as follows:
Taking the words in order there can be no doubt the Company did pay "United Kingdom income tax" on the full amount. The Income Tax Charged "in accordance with the provisions of the Income Tax Acts" was charged on the whole of its profits and gains. Nothing less would have been accepted and no other person was liable to make the payment. But it is urged that even if this be accepted, to the extent of the debenture interest, the payment was made on behalf of the debenture-holders. To this extent that is true, namely, that, having paid, the Company was entitled to deduct the tax from the debenture interest, and, to the extent of that deduction, it was the debenture-holders' tax that was thus discharged. But it was not the debenture-holders who made the payment, but the Company. By*214 Section 209 of the Act of 1918, which remains unrepealed, it is expressly provided that in arriving at the amount of profits or gains for the purpose of Income Tax "no deduction shall be made on account of any annual interest, annuity or other annual payment to be paid out of such profits or gains in regard that a proportionate part of the tax is allowed to be deducted on making any such payment," and by General Rule 19 of the Act of 1918 it is expressly provided that the whole of the profits and gains shall be assessed and charged with tax on the person liable to the interest or annual payment without distinguishing the same. In accordance with this the Company and they alone could be assessed, from them alone was the amount of the assessment claimed, by them alone was it paid, and they were prohibited from making any deduction from such assessment in respect of annual sums charged on their profits.
* * * *
* * * The Company pays tax on the whole of that part of its income which is also subject to Dominion Income Tax and none the less that on making a payment of interest payable out of its profits and gains it deducts, as it is entitled to do, the tax payable by the recipient. *215 The Company is not accountable to the Revenue for this tax nor does its right to deduct it depend upon its having paid its own tax on its profits and gains (see Rule 19 of All Schedules Rules).
This is a clear holding that the English company pays a tax upon the whole of its profits, notwithstanding a part of those profits for tax purposes consisted theoretically of expense items which were made nondeductible by Parliament. The gist of the case is that in so doing the English company pays its own tax and does not account to the Crown for a tax withheld from its*216 payee.
It is foreign to our law to regard the same tax as paid by two different taxpayers. Consequently, if the only tax paid was a tax paid by the English company as its own tax, there is no scope for saying that petitioner also paid the tax. The following quotation from the Biddle case is equally pertinent here:
* * * It can hardly be said that a tax paid to the Crown by a British corporation subject to United States income tax is not a tax paid within the meaning of section 23 (c) (2), of the 1928 act, which allows a deduction from gross income for taxes paid to a foreign country, cf. , or that its stockholders could take credit under section 131 for their share of the tax on the theory that they also had paid it.
The argument is made by petitioner that a tax was imposed upon it by sections 1 and 2 of schedule D, which broadly levy a tax upon gains arising from any property or trade. Upon this ground petitioner seeks to distinguish the Biddle case, inasmuch as dividends, as opposed to royalties, are not regarded in Great Britain as income (for normal tax purposes) *217 in the hands of stockholders. If a tax was imposed upon petitioner, the crucial fact nevertheless remains that petitioner did not pay it. The fact of liability to income tax in and of itself does not justify a credit. It is not enough that under some conceivable circumstances it might have been required to pay. The tax paid in the instant case was not petitioner's tax within the meaning of our statute.
For the foregoing reasons and upon authority of , and , we hold that petitioner is not entitled to the claimed credit.
Judgment will be entered for the respondent.
Footnotes
1. 22. -- (1) If a difference arises --
(a) between tenant and landlord or any other persons with regard to the deduction on account of tax to be made from any annual sum; or
(b) between the occupier for the time being and any former occupier of lands, tenements, hereditaments or heritages, his executors, administrators, or assigns, with regard to the proportion of tax to be paid or allowed by either of them respectively;
the general commissioners of the division shall settle the proportion of the payments or deductions to be made according to the provisions of this Act, and, in default of payment, shall levy the same as if the proportions settled by them had been charged upon the respective persons, and shall pay over the same to the collector or to the proper person, as the case may require.(2) In any such case the determination of the general commissioners shall be final.
(3) In this rule "annual sum" means any interest annuity rent, rentcharge, fee-farm rent, rent-service, quitrent, feu duty, or other rent or annual payment.↩
2. SEC 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.
(a) Allowance of Credit. -- If the taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this title shall be credited with:
(1) Citizen and domestic corporation. -- In the case of a citizen of the United States and of a domestic corporation, the amount of any income war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.↩
3. This may be true with respect to an amount withheld under Rule 21 (1), , which applies where the royalty is paid from other than profits or gains taxable to the payor. In that event the statute plainly directs the payor to withhold the tax and account for it to the Crown. There is no duty to account for amounts deducted under Rule 19 (2), and the payor is liable for his own tax as a taxpayer.↩