United States Court of Appeals, District of Columbia Circuit
April 26, 2018
Appeal from the Decision of the United States Tax Court
Stephen P. Flott argued the cause for appellant. With him on
the briefs were Joseph G. Siegmann and Brittany N. Oravec.
Richard Caldarone, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief were
David A. Hubbert, Deputy Assistant Attorney General, and
Thomas J. Clark, Attorney.
Before: Garland, Chief Judge, and Griffith and Srinivasan,
GRIFFITH, CIRCUIT JUDGE
2007, the foreign shipping corporation Good Fortune Shipping
SA ("Good Fortune") attempted to exempt some of its
U.S.-based income from taxation. But in order to qualify for
the exemption, a certain percentage of Good Fortune's
stock needed to be owned by residents of a country that
provided a reciprocal tax exemption. At that time, the
Internal Revenue Service (IRS) categorically prohibited any
consideration of bearer shares-securities owned by whoever
holds physical certificates issued by the company-when
assessing whether a sufficient amount of a foreign
shipper's stock was owned by qualifying shareholders. The
IRS refused to grant Good Fortune the exemption because all
of the company's stock was made up of bearer shares. Good
Fortune challenged the IRS's approach as inconsistent
with the Internal Revenue Code, and the Tax Court ruled in
favor of the IRS. Because the IRS's regulation
prohibiting consideration of bearer shares unreasonably
interpreted the Code, we reverse.
the Internal Revenue Code (the "Code"), foreign
corporations generally must pay tax on any income derived
from operating ships that transport goods to or from the
United States (called "United States source gross
transportation income"). I.R.C. § 887(a). However,
the Code also historically exempted the income of certain
foreign shippers from this tax. Prior to 1986, federal law
exempted a foreign corporation's shipping income so long
as the corporation registered its ships in a country that
granted "equivalent tax exemptions to U.S. citizens and
U.S. corporations." H.R. Rep. No. 99-841, at 597 (1986)
(Conf. Rep.). This exemption applied "without regard to
the residence of persons receiving the exemption or whether
commerce is conducted in the country of registry." S.
Rep. No. 99-313, at 340 (1986).
exemption did not work as effectively as Congress had
anticipated. Members of Congress had hoped that the
registration-based exemption would encourage the
"international adoption of uniform tax laws" that
eliminated the prospect of double taxation from shippers'
home countries and their countries of operation. S. Rep. No.
67-275, at 14 (1921). Although U.S. shippers were required to
pay U.S. tax on their income, foreign shippers could avoid
the U.S. tax by simply registering (or "flagging
out") their ships in a country that provided a
reciprocal exemption, regardless of whether the ships'
owners had any connection to that country. See S.
Rep. No. 99-313, at 340-41. Congress ultimately found that
this registration-based exemption "place[d] U.S. persons
with U.S.-based transportation . . . at a competitive
disadvantage" compared to foreign shippers who claimed
the U.S. exemption and were not taxed by either their
countries of residence or registration. Id. at 340.
therefore tightened the exemption in the Tax Reform Act of
1986, Pub. L. No. 99-514, § 1212, 100 Stat. 2085,
2536-37. After the 1986 Act, the Code places a four-percent
tax on the U.S. source gross transportation income of
nonresident alien individuals and foreign corporations.
See I.R.C. § 887(a). Congress in 1986 replaced
the registration-based exemption with a new residency-based
exemption for foreign shippers. A foreign shipper can qualify
for the new exemption only if it is "organized in a
foreign country" that "grants an equivalent
exemption to corporations organized in the United
States." Id. § 883(a)(1). However, even a
foreign shipper organized in such a country is ineligible for
the exemption "if 50 percent or more of the value"
of its stock "is owned by individuals who are not
residents" of a country providing a reciprocal
exemption. Id. § 883(c)(1).
2003, the IRS promulgated a regulation elaborating on the
statutory requirement that residents of a country providing a
reciprocal exemption own more than half of the foreign
shipper's stock. See Exclusions from Gross
Income of Foreign Corporations, 68 Fed. Reg. 51, 394 (Aug.
26, 2003) (the "2003 Regulation"). To qualify as an
exempted foreign corporation under the 2003 Regulation, a
shipper must satisfy the "qualified shareholder
test." Under that test, an exempted corporation must
prove, among other things, that "more than 50 percent of
the value of its outstanding shares is owned" by
qualified shareholders, either directly or indirectly through
application of attribution rules, "for at least half of
the number of days in the foreign corporation's taxable
year." 26 C.F.R. § 1.883-4(a) (2007). An individual
is a "qualified shareholder" only if, among other
things, he is a resident of a reciprocating country.
Id. § 1.883-4(b)(1)(i)(A). And a
foreign-corporation shareholder qualifies only if it is
organized in a reciprocating country. Id. §
a foreign corporation claiming an exemption under the
qualified shareholder test "must establish all the facts
necessary to satisfy the [IRS] that more than 50 percent of
the value of its shares is owned . . . by qualified
shareholders." Id. § 1.883-4(d)(1). When
it comes to establishing the facts necessary to demonstrate
corporate ownership, the 2003 Regulation treats differently
"bearer shares" and "registered shares"
of corporate stock. Bearer shares are owned by the
"physical bearer of the stock certificate" and
traditionally have "no recorded ownership
information." Black's Law Dictionary (10th
ed. 2014). On the other hand, "registered shares"
are securities "recorded in the issuer's
books." Id. Under the 2003 Regulation, a
corporation could prove it met § 883(c)(1)'s
ownership requirement by submitting company records proving
up registered shareholders' identities and countries of
residence. See 26 C.F.R. § 1.883-4(d)(4). But a
qualified shareholder may not "own its interest
in the foreign corporation through bearer shares."
Id. § 1.883-4(b)(1)(ii); see also id.
§ 1.883-4(c)(1) ("No attribution will apply to an
interest held directly or indirectly through bearer
shares."); id. § 1.883-4(d)(1) ("A
foreign corporation cannot meet [the stock ownership]
requirement with respect to any stock that is issued in
bearer form. A shareholder that holds shares in the foreign
corporation either directly or indirectly in bearer form
cannot be a qualified ...