Court: Court of Appeals for the Third Circuit; May 28, 1993; Federal Appellate Court
The court addressed whether the corporate surtax levied on Virgin Islands taxpayers under V.I. Code Ann. tit. 33. 581 (Supp. 1990) is deductible from taxable income according to I.R.C. 164 as it applies to the Virgin Islands' 'mirror system' of taxation. The court ruled that the surtax is non-deductible, reversing the district court's judgment and directing a ruling in favor of the Virgin Islands Bureau of Internal Revenue (VIBIR).
The appeal involved two consolidated actions where VIBIR assessed tax deficiencies against Abramson Enterprises, Inc. for the years 1986, 1987, and 1988. Abramson had initially deducted the 10% corporate surtax from its taxable income. The district court first determined the surtax was non-deductible for 1986 but later retracted this decision, concluding the surtax was deductible for all three years, thus invalidating the deficiency notices.
The court's review is based solely on legal interpretation, as all relevant facts were agreed upon by the parties. It also clarified the statutory framework where the Internal Revenue Code applies to the Virgin Islands, enabling a 'mirror system' of taxation that allows Virgin Islands residents to satisfy U.S. tax liabilities by paying income taxes directly to the Virgin Islands treasury. This system requires substitution of 'Virgin Islands' for 'United States' in applicable laws, as highlighted in prior rulings and IRS guidelines.
Under the mirror system, the Internal Revenue Code (I.R.C.) applies to the Virgin Islands, provided the specific section is not clearly inapplicable or incompatible with its income tax system. The 'equality principle' dictates that the tax owed to the Virgin Islands is typically based on what a taxpayer would owe to the U.S. if residing in the mainland. The case examines the applicability of I.R.C. 164 concerning income tax paid by Virgin Islands corporations. I.R.C. 164(a)(3) allows deductions for state and local taxes, while I.R.C. 164(b)(2) defines 'state or local tax' as imposed by U.S. states or territories.
Currently, the applicability of I.R.C. 164 is contested due to a corporate surcharge levied by the Virgin Islands, authorized in 1976 to offset expected revenue losses from the Tax Reduction Act of 1975. This surcharge allows the Virgin Islands legislature to impose up to a 10% surtax on federal income taxes. The legislature did not act on this until ten years later when it enacted a 10% corporate surtax on entities liable for Virgin Islands income tax.
Abramson argues that, under the equality principle, I.R.C. 164 should also apply to this corporate surtax, equating it to a state income tax since it was enacted by the Virgin Islands legislature under congressional authority. Abramson contends that a U.S. taxpayer would be entitled to deduct the surtax under I.R.C. 164, and references the legislative history of the Tax Reduction Act of 1986 to support this position.
TRA 1274(b), enacted in 1986, modifies 26 U.S.C. 932, allowing the Virgin Islands to impose local income taxes without the 10% cap set by 48 U.S.C. 1397. It grants the Virgin Islands the authority to levy nondiscriminatory local income taxes, which are treated like state and local taxes under section 164 of the Internal Revenue Code of 1954, excluding them from section 901. Abramson contends that this provision mandates that any corporate surtax imposed by the Virgin Islands is deductible as a 'state or local tax.' He argues that even if the surtax's nature is ambiguous, legislative history supports treating it as a local tax for I.R.C. 164 purposes. The district court concurred, referencing the Senate Finance Committee's Report, which indicated the surtax authorized by a 1976 amendment to 1397 was considered a local income tax. Consequently, the district court ruled that I.R.C. 164 applies to the corporate surtax, allowing Abramson to deduct it from his Virgin Islands income. However, before determining the surtax's classification, it must first be established whether I.R.C. 164 is applicable in this case. If I.R.C. 164 does not apply, categorizing the surtax as 'local' would be irrelevant. Abramson argued for an 'equality principle' that would ensure he pays no more than a U.S. taxpayer would to the IRS, but this argument was rejected, despite the acknowledgment that if the Virgin Islands were treated as a state, the surtax would be deductible under I.R.C. 164.
Abramson's analogy fails because the Virgin Islands is not a state, and its citizens do not pay federal taxes. The surtax in question is paid to the Virgin Islands Bureau of Internal Revenue (VIBIR) and is not subject to the same deductibility rules as state taxes under federal law. The proposed deduction would allow Abramson to deduct a surtax paid to VIBIR from its taxable income, which the court deems illogical since it undermines the legislative intent of maximizing the surtax at 10% as permitted by federal law (48 U.S.C. 1397). The application of I.R.C. 164 would reduce the effective surtax rate below 10%, contradicting Congress's intention for the Virgin Islands to levy the full surtax. Furthermore, there is no precedent for allowing a tax paid to a taxing authority to be deducted from the same tax owed to that authority. The court highlights that the incorporation of the Internal Revenue Code in the Virgin Islands is limited to compatible provisions and concludes that I.R.C. 164 is not applicable in this case. Additionally, the district court's assertion that the surtax is a 'local' tax relies on a Senate Finance Committee report from nine years after the surtax was authorized, which lacks definitive guidance on the deductibility under I.R.C. 164. The classification of the surtax as 'local' does not inherently grant it the deductibility status envisioned by federal tax law.
The corporate surtax is classified as a federal tax on income, authorized by Congress, distinguishing it from other 'local' taxes imposed by the Virgin Islands legislature, which may be deductible. The surtax, which reduces the overall tax by the same authority, cannot be categorized as a 'local' tax for the purposes of I.R.C. 164. Therefore, even if I.R.C. 164 were applicable, the same conclusion regarding the surtax's nature would prevail. The judgment of the district court will be reversed, directing it to enter judgment for VIBIR. If Abramson were a U.S. taxpayer, it could deduct the Virgin Islands surtax like any other state tax. However, as a Virgin Islands taxpayer, Abramson cannot deduct the surtax from its Virgin Islands taxable income. I.R.C. 901, concerning foreign tax credits, is irrelevant to this case. The court's opinion focuses solely on the deductibility of the Virgin Islands income surtax for its taxpayers and does not address other taxes that may be levied by the Virgin Islands Legislature. The taxing scheme resulting from the district court's ruling is feasible, but Abramson's theory suggests that the Virgin Islands could not achieve a full 10% increase in corporate income tax without adjusting the surtax percentage, which is restricted by 48 U.S.C. 1397. Consequently, the surtax would always remain under a 10% effective rate. VIBIR cites I.R.C. 275, which prohibits deducting federal income taxes from federal taxable income, arguing that under the 'mirror system,' the Virgin Islands corporate surtax deduction cannot be allowed.
