                       115 T.C. No. 17



                UNITED STATES TAX COURT



         MICROSOFT CORPORATION, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 16878-96.                 Filed September 15, 2000.



     During 1990 and 1991, petitioner engaged its wholly
owned subsidiary, a foreign sales corporation, to act as
its agent for the international sales of standardized
mass-marketed computer software products and computer
software masters.   The standardized software products
were copyrighted articles sold without a right to
reproduce abroad. The software masters were licensed to
related foreign subsidiaries and unrelated foreign
equipment manufacturers with a right to reproduce abroad.

     In the notices of deficiency, respondent allowed the
deductions for the foreign sales corporation commissions
attributable to the standardized software products but
denied them with respect to the export of the software
masters.   The issue is whether the software masters
                              - 2 -
     constitute “export property” within the meaning of sec.
     927(a), I.R.C., and sec. 1.927(a)-1T(f)(3), Temporary
     Income Tax Regs., 52 Fed. Reg. 6463 (Mar. 3, 1987) (the
     temporary regulation).

          Held: The temporary regulation is a reasonable and
     valid interpretation of sec. 927(a)(2)(B), I.R.C.

          Held, further, computer software masters do not
     constitute sec. 927(a), I.R.C., “export property”.



     James M. O’Brien, Michael P. Boyle, John M. Peterson, Jr.,

Thomas V.M. Linguanti, Andrew J. Gottlieb, Neal J. Block, Scott H.

Frewing, Robert B. Mitchell, Michael J. Bernard, and William H.

Burkhart, for petitioner.

     David P. Fuller, John M. Altman, Ronald M. Rosen, Kimberley J.

Peterson, Michelle D. Korbas, and Kevin G. Croke, for respondent.



     JACOBS,    Judge:   Pursuant   to    two   notices   of deficiency

addressed to petitioner, respondent determined Federal income tax

deficiencies and an overpayment, as follows:

     Tax Year Ended June 30              Deficiency       Overpayment

               1987                      $6,279,330           ---
               1988                       4,618,862           ---
               1989                       1,644,505           ---
               1990                          ---          $1,944,520
               1991                       8,810,992           ---

     The deficiencies determined for 1987-89 are attributable to

respondent’s adjustments to general business credit carrybacks from
                                  - 3 -
1990 and 1991 to 1987-89 and to foreign tax credit carrybacks from

1990 to 1987 and 1988.         These adjustments are computational,

arising from income adjustments for 1990 and 1991.

                              Introduction

     Petitioner develops, produces, and markets computer software.

During   1990   and   1991,   petitioner   engaged   its    wholly   owned

subsidiary, Microsoft FSC Corp. (MS-FSC), to act as its agent for

the international sales of standardized mass-marketed computer

products and computer software masters.1          These products were

sold/licensed   to    petitioner’s   controlled   foreign    corporations

(CFC’s) and unrelated foreign original equipment manufacturers

(foreign OEM’s).




     1
          Pursuant to the foreign sales corporation provisions
(secs. 921 through 927), a domestic corporation may receive
favorable tax treatment on a portion of its profits from
international sales of its U.S.-made products by selling/leasing
such products through a foreign corporate subsidiary (the foreign
sales corporation). Specifically,

     (1) That portion of the foreign sales corporation’s income
(known as exempt foreign trade income) is not subject to U.S.
taxation in the hands of the foreign sales corporation;

     (2) the domestic corporation may deduct the commission paid
to the foreign sales corporation based upon the amount the
foreign sales corporation reports as foreign trade gross receipts
(using certain administrative pricing rules); and

     (3) the domestic corporation can exclude dividend
distributions from its foreign subsidiary (e.g., the foreign
sales corporation) that are attributable to the foreign sales
corporation’s exempt foreign trade income.
                                         - 4 -
     Pursuant     to    the    licensing         agreements         with    the    CFC’s,

petitioner earned a royalty based upon a percentage of the CFC’s

revenues from the sale of the licensed software products. Pursuant

to the licensing agreements with the foreign OEM’s, petitioner

earned a royalty equal to the greater of the OEM’s computer systems

sales or copies of the computer software products distributed.

     MS-FSC   reported        the   royalties          as   foreign    trading      gross

receipts (FTGR’s). Petitioner paid MS-FSC a commission (based upon

the amount MS-FSC reported as FTGR’s) and deducted the foreign

sales   corporation       (FSC)         commission,         using     the     applicable

administrative pricing rules.

     It is the aforementioned royalties and FSC commissions that

are at issue, namely:

                                          1990                                    1991

Royalties--foreign OEM’s            $155,784,783                            $150,349,955
FSC commissions per
  return                                11,477,502                            5,019,782


Royalties--CFC’s                        55,817,274                          112,887,716
 FSC commissions per
  return                                 4,948,544                           10,321,015

Additional Irish royalties              12,669,936                           16,816,754
Additional FSC commissions
  per petition                           2,914,085                            3,867,853

     Respondent       determined        that     the    disputed      royalties       were

nonqualifying    FTGR’s.      As    a    result,       respondent     disallowed         FSC

commission deductions of $16,426,046 for 1990 (i.e., $11,477,502 +

$4,948,544)     and    $15,340,797         for     1991      (i.e.,     $5,019,782        +
                                   - 5 -
$10,321,015), which petitioner claimed in connection with its

computer    software     masters       exported   for   reproduction      and

distribution abroad.

     Petitioner     also    claimed      FSC   commission   deductions     of

$4,049,134 for 1990 and $13,625,222 for 1991 with respect to its

export sales of standardized software products.             Respondent has

allowed these deductions.

     The dispositive issue to be resolved is whether the royalties

attributable to the licensees’ reproduction and distribution of

petitioner’s computer software masters outside the United States

constitute FTGR’s within the purview of section 924. Resolution of

this issue hinges upon whether the licensed computer software

masters constitute “export property” within the meaning of section

927(a)(1) and the temporary regulations thereunder.

     Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue.            All Rule

references are to the Tax Court Rules of Practice and Procedure.

                            FINDINGS OF FACT

     Some   of    the   facts   have    been   stipulated   and   are   found

accordingly.     The stipulations of facts and the attached exhibits

are incorporated herein by this reference.

A.   Background

     Petitioner, a Washington corporation, maintained its principal

place of business in Redmond, Washington, at the time the petition
                                  - 6 -
was filed.      It was the common parent of an affiliated group of

corporations, which filed consolidated Forms 1120, U.S. Corporation

Income Tax Return, for 1987, 1988, 1989, 1990, and 1991.

      During the years in issue, petitioner conducted its business

through several operating groups:        Systems software, applications

software, systems peripherals and accessories group, OEM sales,

U.S. sales and marketing, international operations, and press.

      Approximately     three-quarters     of   petitioner’s      worldwide

employees were based in Redmond, where petitioner developed its

products.

B.   MS-FSC

      MS-FSC was organized as a Virgin Islands corporation on

December 24, 1984.       On January 1, 1985, petitioner and MS-FSC

entered into a Commission and Expense Agreement, which remained in

effect during the years in issue.         At all relevant times, MS-FSC

elected to be taxed as a foreign sales corporation and was so

qualified.     MS-FSC determined its commission income using section

925(a) administrative pricing rules.

C.   Petitioner’s Products

      Petitioner’s first products were programming languages and

tools   that    permitted   software   developers   to   create   computer

software.      Thereafter, petitioner’s product line was expanded to

include operating systems.      In 1981, petitioner released its first

operating system, “Microsoft Disk Operating System” or “MS-DOS”,
                                   - 7 -
for International Business Machine’s (IBM’s) first microcomputer.

MS-DOS was the operating system used on a majority of IBM’s

personal    computers    and    IBM-compatible     personal     computers.

Petitioner (MS-DOS), IBM (PC-DOS or IBM-DOS), Digital Research (DR-

DOS), and other companies marketed a disk operating system (DOS)

under various names.    DOS was a text or character-based system; it

required computer users to input words or characters to give the

computer commands.      Since 1981, operating systems software has

continually   evolved   to     permit   computer   users   to   accomplish

increasingly diverse and complex tasks on computers.

     In addition to MS-DOS, petitioner marketed other proprietary

operating systems during the years at issue, such as “Microsoft

Windows”, “Microsoft LAN Manager”, and “XENIX”. At that time, MS-

DOS accounted for the largest number of Microsoft operating system

units distributed; Microsoft Windows was second.

     In the early 1980's, petitioner also began to develop and

market application software products in order to increase the

appeal of the microcomputer. Petitioner’s applications included

word processing (e.g., “Microsoft Word”), spreadsheet computations

(e.g., “Microsoft Excel”), graphics (e.g., “Microsoft PowerPoint”),

and video games (e.g., “Microsoft Flight Simulator”).           In 1990 and

1991, petitioner offered a wide line of application software

products.
                                   - 8 -
     Petitioner    created   its   software   products   at   its   Redmond

facilities.     It took 25 to several hundred persons to develop a

computer software product (i.e., Microsoft Windows or Microsoft

Excel).

     Petitioner’s product development, which could take up to 3

years, involved three phases: (1) Product planning, during which a

functional specification and final schedule were prepared (3-12

months); (2) product development, during which the source code was

completed (and was further revised in the next phase) (6-12 months);

and (3) product stabilization, during which a gold master was

produced and the software product was released for duplication (3-8

months).

D.   Production of Masters for Export

     From an American-made gold master, petitioner’s product release

services group (PRS) in Redmond produced master copies of the

software and related documentation for distribution to petitioner’s

Canyon Park facility, the foreign OEM’s, and the CFC’s.              These

masters contained object code for computer programs and related data

files.     Petitioner’s PRS duplicated the masters on various media,

depending upon the size of the particular software product and the

distribution channel.

     Petitioner’s products used magnetic tape for masters provided

to the foreign OEM’s.    Specifically, during the years in issue, PRS

provided masters to the foreign OEM’s on .25-inch magnetic tapes,
                                    - 9 -
5.25-inch diskettes, and 3.5-inch diskettes.

       The software masters remained petitioner’s property and were

unavailable for distribution to third parties.           After petitioner

provided the foreign OEM or CFC with a software master, the licensee

stored the information on a network computer and archived the master

for security or production purposes.        Upon transfer to the network,

the    licensee’s     duplication      equipment   accessed    the    digital

information to initiate duplication runs.

E.    Petitioner’s Export Transactions

       Petitioner     distributed   its     computer   software      products

worldwide. In connection with its sales abroad, petitioner used two

types of channels: (1) The foreign OEM channel, and                  (2)   the

international retail channel.           The products distributed through

these channels were duplicated both in the United States and abroad.

Petitioner’s international revenues (from both the foreign OEM and

retail channels) constituted 54.9 percent of petitioner’s total

revenues for 1990 and 57.3 percent for 1991.

F.    Foreign OEM Channel

       Petitioner’s    foreign   OEM    channel    consisted   of    computer

manufacturers that installed petitioner’s software directly into the

hard drive of a computer and/or “bundled” software-encoded media

along with the computer. The foreign OEM’s distributed petitioner’s

computer software as a component of their own computer systems.
                                           - 10 -
       In 1990 and 1991, approximately 500 foreign OEM’s distributed

petitioner’s software products.               Operating systems constituted the

bulk of these products.

       During these years, approximately 250 foreign OEM’s paid

royalties to petitioner pursuant to the OEM agreements.                     The top 10

products licensed to the foreign OEM’s (ranked in terms of royalties

petitioner accrued) were as follows:

                                    1990                            1991

     Product                Units          Revenue       Units                Revenue

MS-DOS                 7,079,682      $96,742,734      7,726,513           $116,463,986
GW-Basic Interpreter     941,064        6,882,172        762,623             12,535,546
Windows                  760,961        5,779,208      1,686,907              4,378,615
Windows 386              226,552        4,114,398         38,580              4,227,137
OS/2                      22,128        2,784,467        151,267              2,790,240
Shell/DOS                929,728        2,359,430        188,846              2,759,226
MS-Works                 154,732        2,054,785        364,822              2,733,731
LAN Manager                2,942        1,612,589          4,299              1,828,122
Networks                  86,562        1,083,822        171,035              1,534,083
Basic Interpreter        176,279          994,132         60,154              1,427,047

These products represented approximately 75 percent of petitioner’s

foreign OEM licensing revenues for 1990 and approximately 84 percent

for 1991.

       During 1990 and 1991, petitioner also licensed applications and

other software products to the foreign OEM’s.

G.    Standard OEM License Agreement

       Petitioner’s OEM business personnel and legal staff drafted a

standard       (exemplar)    OEM     license     agreement   (the     standard      OEM

agreement) as the basis for negotiating licenses with the foreign

OEM’s. The standard OEM agreement was the starting point from which

negotiations ensued.
                                         - 11 -
       Whether a foreign OEM and petitioner entered into a license

agreement or a distribution agreement depended upon several factors,

such as the foreign OEM’s projected volume of computer sales, the

size   of   the       market   for   a   particular   software   product,   and

petitioner’s confidence in the foreign OEM’s trustworthiness and

recordkeeping.         Pertinent provisions of the standard OEM agreement

include the following provisions:

       2.   LICENSE GRANT

            (a) MS [Microsoft] grants to COMPANY [licensee] the
       following nonexclusive, worldwide license rights:

                  (i)     to adapt the Product as necessary
             to enable it to execute on COMPANY’s Customer
             System(s);

                  (ii)    to reproduce and manufacture the
             Product in object code form; and

                 (iii)   to distribute directly or
            indirectly and license the Product in object
            code form to end users, under the terms of
            COMPANY’s end user license agreement.

            All rights not expressly granted, including without
       limitation translation rights, are reserved by MS.

                  *       *      *        *       *   *     *

       7.   COPYRIGHT NOTICES; TRADEMARKS

            (a) COMPANY will cause to appear on the container
       and labels of each copy of Product, the copyright and
       patent notices for the Product that appear on the
       applicable release of the Product as provided to COMPANY
       pursuant to Section 2 hereof * * *

            (b) COMPANY shall market the Product only under the
       Product name(s) for such Product as specified * * * and
       COMPANY agrees to use the appropriate trademark symbol *
       * * and clearly indicate MS’ ownership of its
                         - 12 -
trademark(s) whenever the Product name is first mentioned
in any advertisement, brochure or in any other manner in
connection with the Product. COMPANY’s name and/or
trademarks shall not be displayed in relation to the
Product name in a manner which suggests that COMPANY’s
name and/or trademarks are part of the Product name.
COMPANY agrees to maintain the high level of quality
accorded products associated with and marketed by MS
under MS’ trademarks. COMPANY shall not use or display
any MS logo in its materials or packaging without MS’
prior written permission.     COMPANY shall not use or
imitate the trade dress of MS products. COMPANY’s name
and/or trademarks shall be displayed on the packaging and
disk labels for the Product at least as prominently as
the name “Microsoft.” Upon request, COMPANY shall submit
the Product in proposed finished goods form (including
software and documentation) to MS for approval prior to
distribution, which approval shall not be unreasonably
withheld.    COMPANY shall, upon request, provide MS
samples of all COMPANY literature which uses Product
name(s). COMPANY shall provide MS with five (5) copies
of the Product in finished goods form.

         *     *     *      *     *    *      *

13.   NONDISCLOSURE AGREEMENT

COMPANY expressly undertakes to retain in confidence and
to require its distributors to retain in confidence all
information and know how transmitted to COMPANY by MS
that MS has identified as being proprietary and/or
confidential or that, by the nature of the circumstances
surrounding the disclosure, ought in good faith to be
treated as proprietary and/or confidential, and will make
no use of such information and know-how except under the
terms and during the existence of this Agreement.
However, COMPANY shall have no obligation to maintain the
confidentiality of information that (i) it received
rightfully from another party prior to its receipt from
MS; (ii) MS has disclosed to a third party without any
obligation to maintain such information in confidence; or
(iii) is independently developed by COMPANY. Further,
COMPANY may disclose confidential information as required
by governmental or judicial order, provided COMPANY gives
MS prompt notice of such order and complies with any
protective order (or equivalent) imposed on such
disclosure. COMPANY shall treat all Product adaptation
materials (including source code) as confidential
                                - 13 -
     information and shall not disclose, disseminate or
     distribute such materials to any third party without MS’
     prior written permission. COMPANY shall treat the terms
     and conditions of this Agreement as confidential;
     however, COMPANY may disclose such information in
     confidence to its immediate legal and financial
     consultants as required in the ordinary course of
     COMPANY’s business.    COMPANY’S obligation under this
     Section 13 shall extend to the earlier of such time as
     the information protected hereby is in the public domain
     through no fault of COMPANY or ten (10) years following
     termination or expiration of this Agreement.

               *      *     *     *      *    *     *

     16.   CONTROLLING LAW; NO FRANCHISE

          (a) This    Agreement   shall  be   construed   and
     controlled by the laws of the State of Washington, and
     COMPANY consents to jurisdiction and venue in the state
     and federal courts sitting in the State of Washington. *
     * *

               *      *     *     *      *    *     *

     18.   GENERAL

               *      *     *     *      *    *     *

          (f) The Section headings used in this Agreement and
     the attached Exhibits are intended for convenience only
     and shall not be deemed to supersede or modify any
     provisions.

     The OEM agreements granted the licensee the right to modify,

reproduce, and distribute the licensed software (and derivative

work) on or with the foreign OEM’s hardware systems specified in

each agreement.    The royalties at issue were paid as consideration

pursuant to these agreements, which computed the royalty on a “per

copy” or “per system” basis.    The foreign OEM’s paid a royalty for

each copy of the copyrighted work duplicated and distributed in the
                                   - 14 -
market, or for each computer system manufactured and sold by the

foreign OEM’s.

     The OEM agreements required the foreign OEM’s to make minimum

commitment payments quarterly.        To the extent earned royalties

exceeded the cumulative minimum commitment payments, the foreign

OEM’s were required to pay petitioner for actual earned royalties.

To the extent cumulative minimum commitment payments exceeded actual

earned royalties, the excess was considered prepaid royalties and

was recoupable against future earned royalties during the term of

the license agreement.

     The standard OEM agreement was for a 2-year term.         The foreign

OEM’s generally extended their relationship with petitioner by

entering into subsequent agreements licensing later releases and

versions of the same software.

     The proprietary information petitioner transferred to the

foreign   OEM’s   (pursuant   to   the   standard    OEM   agreement)   was

maintained as a trade secret. The parties have stipulated that this

proprietary information included algorithms, processes, formulas,

and designs.

     The foreign OEM’s could also license petitioner’s source code

for specific products pursuant to a separate, royalty-bearing

license arrangement (source code license).          A source code license

authorized the foreign OEM to use the source code solely for
                                - 15 -
“internal use” in furtherance of its license to adapt, reproduce,

and distribute the computer software in object code form. Pertinent

provisions of the source code license are as follows:

     19.     LICENSE GRANT FOR SOURCE CODE

          (a) MS grants to COMPANY a nonexclusive, personal,
     nontransferable, nonassignable license during the term of
     the Agreement to use and modify the source codes of the
     Products (“Source Code”) * * *

          (b) The license granted hereunder shall extend to
     the Source Code for any new releases to each Product as
     are supplied by MS and accepted by COMPANY. * * *

          (c) COMPANY hereby conveys to MS all right, title
     and interest to any modifications made to the Source Code
     by COMPANY. MS grants to COMPANY non-exclusive marketing
     and distribution rights to the object code version of any
     modifications made to the Source Code by COMPANY * * *

          (d) Notwithstanding anything to the contrary
     contained herein, COMPANY shall not reproduce, duplicate,
     copy or otherwise disclose, distribute or disseminate
     Source Code (code or listing) in any media except for
     COMPANY’s own internal use by COMPANY’S full-time
     employees on a need-to-know basis on COMPANY premises. *
     * *

The foreign OEM’s paid royalties for the source code in addition to

other royalty payments.

     In some instances, petitioner provided a foreign OEM with an

OEM adaptation kit (OAK), which contained a copy of the product’s

object code, sample adaptation code, and related documentation.   An

OAK assisted foreign OEM’s to adapt operating systems to personal

computers.      Whether a foreign OEM needed the adaptation code

depended on its particular computers.
                               - 16 -
H.   International Retail Channel

      In 1990 and 1991, petitioner exported shrink-wrapped software2

products (made in the United States) to its CFC’s for distribution

to end users outside the United States.          In addition, petitioner

licensed its CFC’s the rights to duplicate and distribute shrink-

wrapped software packages outside the United States pursuant to CFC

(or product localization) agreements.      In most instances, the CFC’s

localized petitioner’s software and then manufactured copies of the

localized software for distribution as shrink-wrapped products.

      The CFC’s in Ireland (Microsoft Ireland), Japan (Microsoft

Japan), Korea (Microsoft Korea), and Taiwan (Microsoft Taiwan)

reproduced, packaged, and distributed retail products            for   the

international retail channel, as well as white box products for the

international OEM channel.     (A “retail” product consisted of an

individual copy of the software marketed in a decorative retail box

(shrink-wrapped software), containing software-loaded storage media,

user manuals, and other documentation.           A “white box” product

consisted   of   software-loaded   media   and    product   documentation

packaged in a plain white box, intended to deter separate retail

sales by a foreign OEM.) Microsoft Ireland manufactured both retail



      2
          Shrink-wrap packaging consisted of packing the
software-loaded diskettes with manuals and other printed
materials in shrink-wrapped boxes bearing graphics, product
information, trademark registrations, trade names, and other
trade dress. The warehousing operation consisted of storing and
shipping the shrink-wrapped software packages.
                                       - 17 -
and white box products from masters petitioner supplied.              Microsoft

Japan, Microsoft Taiwan, and Microsoft Korea used subcontractors to

duplicate and distribute both retail and white box products.

       The CFC agreements with Microsoft Taiwan, Microsoft Korea, and

Microsoft Japan imposed a mandatory trademark branding requirement

on the CFC’s.     The CFC agreements with Microsoft Ireland included

an express trademark license.

        Petitioner generally sent the master diskettes to the CFC’s

containing object code for the licensed retail products.                 Similar

to the OEM agreements, the CFC agreements imposed obligations on the

CFC’s    to   maintain      in   confidence   all   trade   secret   information

petitioner provided.

       Pursuant to the CFC agreements, petitioner ultimately received

royalties from the CFC’s.            MS-FSC reported the royalties on its

returns as FTGRs from transactions in qualifying export property.

The royalties in dispute are those received from Microsoft Japan,

Microsoft Korea, Microsoft Ireland, and Microsoft Taiwan in 1990 and

1991, paid      pursuant to the CFC agreements.             During the years in

issue, Microsoft Ireland accounted for approximately 85 percent of

petitioner’s royalty accruals from the CFC’s.

       Petitioner did not allocate or apportion the royalty stream

from    the   CFC’s   and    OEM’s   among    intellectual    property   rights.

Respondent determined that the royalties petitioner accrued from its

export licensing transactions were not FTGR’s on the basis that the
                                 - 18 -
royalty income did not arise from transactions in export property

(i.e., the income arose from disqualified intangibles).

                                 OPINION

A.   The Statutes

     In 1971, Congress enacted the domestic international sales

corporation (DISC) provisions (sections 991 through 997), see

Revenue Act of 1971, Pub. L. 92-178, sec. 501, 85 Stat. 497, 535,

to provide an export tax incentive to U.S. businesses and to improve

the country’s balance of payments, see S. Rept. 92-437, at 90

(1971), 1972-1 C.B. 559, 609.       The DISC provisions attempted to

equalize tax treatment between U.S. companies that sold goods in

foreign markets regardless of whether the goods were made in the

United States.      These provisions allowed domestic corporations to

defer taxes on a substantial portion of profits from export sales

(similar to the tax benefits available to corporations manufacturing

abroad through foreign subsidiaries).      See H. Rept. 92-533, at 58

(1971), 1972-1 C.B. 498, 529; S. Rept. 92-437, supra at 90, 1972-1

C.B. at 609.

     In 1984, Congress supplemented the DISC provisions with the

foreign sales corporation (FSC) provisions (sections 921 through

927), see Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 801,

98 Stat. 494, 985, in order to comply with the General Agreement on

Tariffs and Trade, see S. Prt. 98-169 (Vol. I), at 635 (Comm. Print

1984). Under the FSC provisions, a taxpayer may permanently exclude
                                - 19 -
from Federal income tax a portion of its profits from qualifying

export sales.3

     Both the DISC and the FSC provisions reallocate a portion of

a U.S. company’s profits attributable to its export of American-made

products.   The proper amount of the reallocation for 1990 and 1991

is in controversy.

     Only activities that generate FTGR’s qualify for FSC benefits.

 FTGR’s are the gross receipts of an FSC that are:

          (1) from the sale, exchange, or other disposition
     of export property,

          (2) from the lease or rental of export property for
     use by the lessee outside the United States,

            (3)   for services which are related and subsidiary
     to–-




     3
          On Feb. 24, 2000, the World Trade Organization (WTO)
appellate body upheld an October 1999 WTO panel ruling that the
U.S. foreign sales corporation (FSC) tax regime is essentially an
export subsidy in contravention of WTO rules. The panel
recommended that the United States comply with the WTO ruling by
Oct. 1, 2000, or face the prospect of European Union retaliation.
     In May 2000, the United States proposed to the European
Union an FSC replacement system, with tax benefits generally
applying to foreign income from all foreign sales, rentals, and
leases, regardless of whether goods are manufactured in the
United States or abroad. The European Union rejected this
proposal, maintaining that the system would continue to make tax
benefits contingent upon exports.
     As of the release date of this Opinion, H.R. 4986, 106th
Cong., 2d Sess. (2000), the FSC Repeal and Extraterritorial
Income Exclusion Act of 2000, is under consideration in order to
bring the U.S. export tax regime into conformity with the WTO
ruling.
                                   - 20 -
                 (A) any     sale,   exchange,   or  other
            disposition   of   export   property  by  such
            corporation, or

                 (B) any lease or rental of export
            property described in paragraph (2) by such
            corporation,

          (4) for engineering or architectural services for
     construction projects located (or proposed for location)
     outside the United States, or

          (5) for the performance of managerial services for
     an unrelated FSC or DISC in furtherance of the production
     of foreign trading gross receipts described in paragraph
     (1), (2), or (3).

Sec. 924(a).

     The    FSC   and   DISC   provisions   define   “export   property”   as

property “manufactured, produced, grown, or extracted in the United

States”.4      Secs.    927(a)(1)(A),   993(c)(1)(A).     However,   export

property does not include:

            patents, inventions, models, designs, formulas,
            or   processes,   whether  or   not   patented,
            copyrights (other than films, tapes, records,
            or similar reproductions, for commercial or
            home use), good will, trademarks, trade brands,
            franchises, or other like property.

Secs. 927(a)(2)(B), 993(c)(2)(B). These sections expressly exclude

intangible property from the definition of export property. The

parenthetical phrase “other than films, tapes, records, or similar

reproductions, for commercial or home use” (the parenthetical)



     4
          The parties have stipulated that for purposes of this
case, petitioner’s software development in the United States
satisfied the manufacture or production requirement of sec.
927(a)(1)(A).
                               - 21 -
limits the unfavorable treatment with regard to copyrights.5

B.   The Regulations

      Section 1.993-3(f)(3), Income Tax Regs., T.D. 7514, 1977-2 C.B.

266, was issued on October 14, 1977,6 excluding copyrights in books

from export property treatment.    Section 1.993-3(f)(3), Income Tax

Regs., provides:

                (3) Intangible property. Export property
           does not include any patent, invention, model,
           design, formula, or process, whether or not
           patented, or any copyright (other than films,
           tapes, records, or similar reproductions, for
           commercial or home use), goodwill, trademark,
           tradebrand, franchise, or other like property.
           Although a copyright such as a copyright on a
           book does not constitute export property, a


      5
          The Taxpayer Relief Act of 1997, Pub. L. 105-34, sec.
1171, 111 Stat. 788, 987, amended sec. 927(a)(2)(B). As a
result, copyrights of computer software are explicitly referred
to as not being excluded property (i.e., such copyrights qualify
as export property). The amendment applies to gross receipts
from computer software licenses attributable to periods after
1997, in tax years ending after Dec. 31, 1997.
     The conference report accompanying the Taxpayer Relief Act
of 1997 states that no inference is intended as to the
qualification of computer software licensed for reproduction
abroad as export property under the pre-1997 law. See H. Conf.
Rept. 105-220, at 636 (1997), 1997-4 C.B. (Vol. 2) 1457, 2106.
In reaching our conclusions, we have adhered to this
pronouncement.
      6
          On Oct. 12, 1977 (2 days before sec. 1.993-3(f)(3),
Income Tax Regs., was issued), the Acting Commissioner of the
Internal Revenue Service sent a memorandum to the Assistant
Secretary of the Treasury recommending approval of sec. 1.993-
3(f)(3), Income Tax Regs., and attached a technical memorandum in
support thereof. The technical memorandum recognized that:
(1) The parenthetical described a limited category of copyright
rights; and (2) sound recording copyrights fell within the
limited category of copyrights saved by the parenthetical.
                               - 22 -
          copyrighted article (such as a book) if not
          accompanied by a right to reproduce it is
          export property if the requirements of this
          section are otherwise satisfied.    However, a
          license of a master recording tape for
          reproduction outside the United States is not
          disqualified under this subparagraph from being
          export property.

      Section 1.993-3(f)(3), Income Tax Regs., does not explicitly

refer to computer software.        Consequently, the Commissioner’s

position with respect to whether computer software qualifies as

export property for DISC purposes was later expressed through the

following pronouncements:    (1) Gen. Couns. Mem. (GCM) 39,449 (Feb.

17,   1983),    concluded   that   mass-marketed   software   without

reproduction rights may qualify as export property under the DISC

rules as being akin to a copyrighted book; (2) Tech. Adv. Mem. (TAM)

85-49-003 (Aug. 16, 1985), concluded that standardized, mass-

marketed computer software without reproduction rights is section

993(c) export property; and (3) Priv. Ltr. Rul. (PLR) 86-52-001

(Sept. 3, 1986), concluded that exported computer software updates

that were not copyrighted would qualify for DISC benefits because

the property was sold without reproduction rights.     (We recognize

that GCM’s, TAM’s, and PLR’s do not have the force of law and are

not binding on us.   We mention these pronouncements merely to show

the manner in which the Commissioner interpreted and/or applied the

regulations.)
                              - 23 -
     On March 3, 1987, the Secretary promulgated section 1.927(a)-

1T(f)(3), Temporary Income Tax Regs., 52 Fed. Reg. 6463 (Mar. 3,

1987) (the temporary regulation), effective for taxable years

beginning after December 31, 1984.     The preamble to the temporary

regulation states, in relevant part:

               Section 1.927(a)-1T provides definitions
          of export property for purposes of the FSC
          rules. These definitions parallel in all
          important respects the definitions of export
          property of a DISC at §1.993-3. These
          regulations at §1.927(a)-1T(f)(3) provide that
          export    property   will    include    certain
          standardized computer software on media that
          are   mass-marketed  without   the   right   to
          reproduce for external use. * * * [Emphasis
          added.]

52 Fed. Reg. 6433.

     The temporary regulation provides:

               (3) Intangible property. Export property
          does not include any patent, invention, model,
          design, formula, or process, whether or not
          patented, or any copyright (other than films,
          tapes, records, or similar reproductions, for
          commercial or home use), goodwill, trademark,
          tradebrand, franchise, or other like property.
          Although a copyright such as copyright on a
          book or computer software does not constitute
          export property, a copyrighted article (such as
          a book or standardized, mass marketed computer
          software) if not accompanied by a right to
          reproduce for external use is export property
          if the requirements of this section are
          otherwise   satisfied.      Computer   software
          referred to in the preceding sentence may be on
          any medium, including, but not limited to,
          magnetic tape, punched cards, disks, semi-
          conductor chips and circuit boards.   A license
          of a master recording tape for reproduction
          outside the United States is not disqualified
                                   - 24 -
          under   this     paragraph     from     being   export
          property.

(The emphasized portions reflect additions or changes from the

language of section 1.993-3(f)(3), Income Tax Regs.)

     Following the promulgation of the temporary regulation, the

Commissioner issued the following: (1) PLR 92-100-15 (Mar. 6, 1992)

concluded that even though the software therein was not subject to

a   copyright,    the   license    agreement    restricted   its   use   and

reproduction, qualifying it as export property; (2) PLR 93-440-02

(May 27, 1993) concluded that a master computer disk provided to

distributors, accompanied by a right to reproduce, is not export

property; also, “tapes” in the parenthetical refers to audio or

video tapes used in the entertainment industry and does not apply

to magnetic tapes used in the computer software industry; and (3)

TAM 93-44-002 (May 27, 1993) concluded that “computer software

conveyed through a licensing agreement that gives the licensee the

right to reproduce the software is excluded from the term ‘export

property’”.      Also, the technical advice memorandum reflected that

the temporary regulation limited the reproduction exclusion of

section   927(a)(2)(B)     to     reproductions    used   solely   in    the

entertainment industry, stating, in relevant part:

               The parenthetical exception in section
          927(a)(2)(B) of the Code and section 1.927(a)-
          1T(f)(3) of the regulations, which is identical
          to and based on the parenthetical exception in
          section 993(c)(2)(B) should also be interpreted
          to include only audio or video tapes used in
          the entertainment industry and not magnetic
          computer software tapes.
                              - 25 -
C.   Industry Position

      Before enacting the FSC regime, the Senate Finance Committee

received written submissions and held hearings on February 3, 1984.

See Hearings on S. 1804 Before the Senate Comm. on Finance, 98th

Cong., 2d Sess., Part 2 of 2 (1984).      Representatives from the

software industry testified that the DISC provisions were unclear

as to the treatment of exported computer software copyrights.      In

this regard, Gerald K. Howard, vice president for taxes, Sperry

Corp. (representing several computer, business, and electronics

associations), stated:

     we ask that a DISC rule that has caused us some
     difficulty in the past be modified or clarified, namely
     that * * * the definition of qualified export property be
     revised to include software. We believe that this will
     assist in eliminating the uncertainty that exists in the
     tax law concerning software. * * *

           We don’t believe it was intended for the high
      technology industry to suffer a decrease in the tax
      incentives that are provided and we ask that software be
      included in the definition of export property. * * *
      [Emphasis added.]

 Id. at 123.   The software industry’s request went unheeded.

      In 1993, software industry representatives again attempted to

convince Congress to amend the FSC rules to “clarify” that exports

of software qualify for FSC benefits that are available to other

exports.   Legislation to make such “clarification” was introduced.

Hearings on H.R. 63 Before Subcomm. on Select Revenue Measures,

House Ways and Means Comm., 103d Cong.,   1st   Sess.,   Part   1 of 3
                                      - 26 -
(1993).      A     software   industry      representative      summarized   the

industry’s position as follows:

            The failure to permit exports of computer
            software to qualify for FSC treatment is
            counterproductive and inconsistent with the U.S.
            interest in fostering the continued growth of
            this industry in the United States.           In
            addition, there is no tax policy reason for
            denying exporters of software the tax benefits
            of the FSC rules that are available to other
            U.S. exporters and in particular the film and
            record industries * * *. There is a need for
            Congress to clarify the original intent of the
            DISC and FSC legislation to encourage U.S.
            exports, including software, in light of the
            Treasury Department’s temporary FSC regulations.
            Therefore, we respectfully request that Congress
            enact legislation which would clarify that the
            definition of FSC export property includes the
            license of computer software to foreign
            distributors and customers with the right to
            reproduce.

Id. at 644 (statement by James A. Abrahamson, chairman of the board,

Oracle    Corp.,   on   behalf   of   the    FSC   software    coalition).   In

addition,    the     representative      complained     that     the   temporary

regulation “adopted a narrow interpretation of the parenthetical

exception and denied any FSC benefits for the license of computer

software if the license is accompanied by the right to reproduce the

computer software.”      Id. at 643.        These hearings did not result in

a change to section 927(a)(2)(B).

     Over the next several years, over 100 members of Congress

requested that the Department of the Treasury amend the temporary

regulation to explicitly extend FSC benefits to the export of

computer software licenses that include reproduction rights abroad.
                                 - 27 -
See   141 Cong.   Rec.   S16,086-S16,087   (daily   ed.   Oct.   27,   1995)

(statement of Sen. Hatch); 140 Cong. Rec. H3428 (daily ed. May 17,

1994) (statement of Rep. Lantos).       The Department of the Treasury

maintained     that an “expansion” of the scope of the FSC rules

required legislative action.     140 Cong. Rec. H3428 (daily ed. May

17, 1994) (letter from Secretary of the Treasury Bentsen to Rep.

Lantos (May 6, 1994)).      Legislation was introduced to expressly

include the sale or licensing of computer software for use outside

the United States, even when accompanied by a right to reproduce,

within the definition of FSC export property.        See 141 Cong. Rec.

S16,086-S16,087 (daily ed. Oct. 27, 1995). This legislation was not

enacted; thus, section 927(a)(2)(B) remained intact.

D.    The Parties’ Positions

      The threshold question before us is whether copyrights in

computer software fall within the parenthetical.            According to

respondent:

                 The parenthetical describes the narrow
            subset of copyright rights that Congress
            intended to “save” from the general rule
            excluding intangibles from export property. The
            parenthetical describes only copyright rights in
            motion pictures and sound recordings. The
            parenthetical was not intended to, and does not,
            refer to copyrights fixed on various media
            without regard to the nature of the copyrighted
            content.

Thus,   respondent   maintains   that   “the   parenthetical     refers   to

particular kinds of content fixed on the media that are mentioned in

the parenthetical, and any similar media that might be invented in
                                     - 28 -
the    future.”     Reading    the   statute   in   a     restrictive   manner,

respondent reasons that “The phrase ‘similar reproductions’ means

similar content on other media, not simply any content on similar

media.”       Respondent maintains that regardless of the medium upon

which it is fixed, computer software is neither a motion picture nor

a     sound    recording.    According    to   respondent,      a    computer’s

functionality distinguishes computer software from motion pictures

and sound recordings.

       On the other hand, petitioner maintains that computer software

masters are the same as or similar to motion pictures and sound

recording masters.          Thus, petitioner asserts that the software

masters are “similar reproductions” to motion pictures and sound

recordings.

       Specifically, petitioner claims:

              “films, tapes, records” as used in section
              927(a)(2)(B) denote tangible media on which
              images, sounds, and/or other information is
              recorded and stored.    These media differ in
              terms of their specific physical attributes
              (e.g., a strip of photosensitive cellulose
              acetate, a plastic strip coated with magnetic
              powder, a spiral grooved disc). All three types
              of media, however, require a machine to read
              back the recorded content to the consumer or end
              user. In other words, they are inherently and
              necessarily machine-readable media.

Continuing,       petitioner     posits    that     the     phrase      “similar

reproductions” (within the purview of the parenthetical) refers to
                                        - 29 -
copyrighted work distributed on machine-readable media, existing or

emergent, in addition to “films, tapes, and records”.

       To   restate     the     parties’      positions:    in    concluding      that

copyrights in computer software do not constitute export property,

respondent asserts that “films, tapes, and records” are content-

specific and that “similar reproductions” refers to “films, tapes,

and   records”   on     media    that    might   be    invented   in   the   future.

Conversely, in concluding that copyrights in computer software

constitute export property, petitioner asserts that “films, tapes,

and records” are media-specific, denoting the tangible media upon

which images, sounds, and/or other information is recorded and

stored, and that “similar reproductions” means any information that

can be recorded on a recording medium (such as reel-to-reel films,

Betamax or VHS videocassettes, DVD’s, vinyl records, reel-to-reel

tapes, 8-track tapes, cassette tapes, diskettes, hard disk drives,

and CD’s).

E.    Analysis

       1.   Statutes

       As a general rule, patents, inventions, copyrights, and other

intangibles are not granted export property treatment for purposes

of    FSC   benefits;    rather,     they     are     “excluded   property”.      Sec.

927(a)(2)(B).     We     believe        the    exception    (contained       in   the

parenthetical) to this general rule should be narrowly interpreted.
                                         - 30 -
     In our opinion, the parenthetical refers to specific kinds of

content, not any content placed on machine-readable media, as

petitioner maintains.            When section 993(c)(2)(B) was enacted in

1971, no one could foresee the future media on which films and sound

recordings might be distributed.            Because of this unknown, Congress

included the phrase “similar reproductions” in the parenthetical.

     “Reproduction” is an exact copy of particular preexisting

content fixed on a medium. Blank tapes are not reproductions of each

other (but are manufactured).               Copyright concerns content, not

media.     Indeed, a copyright is defined as “A property right in an

original work of authorship (such as a literary, musical, artistic,

photographic,      or   film     work)    fixed   in   any   tangible    medium   of

expression, giving the holder the exclusive right to reproduce,

adapt, distribute, perform, and display the work.”                      Black’s Law

Dictionary 337 (7th ed. 1999); see 17 U.S.C. sec. 102(a) (1988).

Clearly,    petitioner      does     more    than      distribute   blank    tapes;

petitioner’s products are sold because of the content on the medium.

     Were    we    to   accept    petitioner’s      broad    interpretation    that

“similar    reproductions”        covers    all   content    on   machine-readable

media, then revenues from the sale or lease of copyrights in

practically all products (existing and yet to be invented) would

qualify for FSC benefits.

     The    only    copyrights      Congress      affirmatively     identified    as

qualifying for export property treatment were copyrights in motion
                                       - 31 -
pictures and sound recordings when it enacted section 993(c)(2)(B)

(relating to DISCs) in 1971 and section 927(a)(2)(B) (relating to

FSC’s) in 1984.         The parenthetical in both sections does not

explicitly refer to computer software masters.

      Computer    software    causes     a   computer     to     perform    countless

functions.    Operating      systems    software       makes    a   general-purpose

computer function by controlling (1) the operation of the computer’s

hardware components, (2) the execution of applications, (3) the

sequencing of tasks, and (4) the flow of information within the

computer    system.      When     combined      with    data    and   the    hardware

components   of    a   computer     system,     computer       software     enables   a

computer to enter, store, process, and display information, thereby

performing specific tasks.             Without software, computers cannot

function.    To illustrate, if an audio CD is placed in the CD drive

of a personal computer, it can be played only if a computer program

has been loaded into the computer that instructs the computer how to

play the CD.      An audio CD does not make the computer function; the

computer software does.       Removal of the audio CD does not remove the

ability of the computer to play a different audio CD.                      Yet if the

software is not installed, the audio CD cannot be played.

      Unlike software, motion pictures and sound recordings do not

cause a computer to function.          They are played on machines designed

to   play   them (but    do   not    cause      the    machine      to     function).
                                      - 32 -
The mere fact that sound or video recordings can be digitally

represented does not transform them into computer software.

      Computer     software    is    fundamentally      different     from    motion

pictures     and   sound   recordings.         Within     the    purview     of   the

parenthetical, (1) “films, tapes, and records” are content specific,

and   (2)   “similar   reproductions”       refers   to    “films,     tapes,     and

records” on media that might be invented in the future.                 In sum, we

hold that copyrights in computer software do not constitute section

927(a) “export property”.           Support for this holding is found in the

temporary regulation to which we now turn our attention.

      2.    Interpretation of the Temporary Regulation

      Generally, temporary regulations have binding effect and are

entitled to the same weight as final regulations.                  See UnionBanCal

Corp. v. Commissioner, 113 T.C. 309, 316 (1999); Peterson Marital

Trust v. Commissioner, 102 T.C. 790, 797 (1994), affd. 78 F.3d 795

(2d Cir. 1996).      We interpret temporary regulations in toto rather

than phrase by phrase.        See Norfolk Energy, Inc. v. Hodel, 898 F.2d

1435, 1442 (9th Cir. 1990).

      The temporary regulation comports with the language of the

statute.     It succinctly states that, although copyrights do not

constitute export property, copyrighted articles, such as computer

software, do qualify as long as the article is not accompanied by a

right to reproduce outside the United States.                   Permitting a right
                                      - 33 -
to reproduce abroad would facilitate reproduction activity outside

the United States.     That is not the result intended.

     The temporary regulation contains four sentences.                The first

sentence is virtually identical to the language of the statute.                It

states that intangibles (other than certain copyrights) are not

export property.

     The introductory clause of the second sentence applies the

general rule that a copyright is not export property, giving books

and computer software as examples of items subject to the general

rule (disqualifying intangibles).         The second sentence states that

a copyrighted article exported without the right to reproduce for

external use is export property (so long as the other requirements

are met).

     The third sentence expands upon the second sentence.                    Read

together, the two sentences provide that computer software on any

medium (i.e., magnetic tape, punched cards, or disks), if not

accompanied by a right to reproduce outside the United States, is

export property.      By rendering the medium irrelevant, the third

sentence distinguishes among copyrights based upon their content.

     The fourth sentence is identical to the last sentence of

section 1.993-3(f)(3), Income Tax Regs.           It was therein inserted to

address   the    concern   of   the   sound    recording   industry   that   the

parenthetical was not written broadly enough to include its industry

practices.      Specific reference to computer software in the second
                                  - 34 -
and third sentences of the temporary regulation would not have been

made (in 1987) to contradict the fourth sentence (which was carried

over from section 1.993-3(f)(3), Income Tax Regs., to the temporary

regulation).

     According to petitioner, computer software masters are “master

recording   tapes”   (within    the    purview   of   the   fourth   sentence)

licensed for reproduction outside the United States, and thus

constitute export property.           We disagree.     Read in context, a

“master recording tape” does not include computer software.

     Because the second sentence interprets the general rule (that

copyrights are not export property), “reproduction” in the fourth

sentence refers to a copyright transaction described in the second

sentence.      The fourth sentence emphasizes that sound recording

masters fall within the parenthetical and thus are not disqualified

by the second sentence.        Contrary to petitioner’s assertion, the

fourth sentence is not “trumped” by the second sentence because the

fourth sentence concerns a “master recording tape” whereas the

second sentence concerns computer software and books.                 (It was

unnecessary to refer to motion pictures in the fourth sentence

because the legislative history reflects that copyrights in motion

pictures fall within the exception, and the motion picture industry

did not lobby for modification.) Petitioner’s interpretation of the

fourth sentence would nullify, rather than harmonize with, other

provisions of the temporary regulation.
                                      - 35 -
      In sum, we hold that pursuant to the temporary regulation,

copyrighted computer software with a right to reproduce abroad does

not qualify as export property.

      3.    Validity of the Temporary Regulation

      We now turn our attention to petitioner’s alternative argument

that the temporary regulation is invalid.

      The    temporary    regulation    was    promulgated   pursuant   to     the

general authority granted to the Secretary by section 7805(a), not

pursuant     to    specific    legislative      authority.     Thus,     it     is

interpretive, see Jackson Family Found. v. Commissioner, 97 T.C. 534

(1991), affd. 15 F.3d 917 (9th Cir. 1994), and should be upheld if

it   is    found   to   “‘implement   the   congressional    mandate    in    some

reasonable manner’”,       United States v. Cartwright, 411 U.S. 546, 550

(1973) (quoting United States v. Correll, 389 U.S. 299, 307 (1967)).

We defer to a regulation if it is a reasonable and permissible

interpretation of the statute.         See, e.g., Atlantic Mut. Ins. Co. v.

Commissioner, 523 U.S. 382, 389 (1998); National Muffler Dealers

Association, Inc. v. United States, 440 U.S. 472, 488-489 (1979).

      It is not our function to decide what the best or most

advisable method would be to implement the Internal Revenue Code.

As the Supreme Court stated in United States v. Correll, supra at

307: “Congress has delegated to the Commissioner, not to the courts,

the task of prescribing ‘all needful rules and regulations for the
                                   - 36 -
enforcement’ of the Internal Revenue Code.”            The delegation helps

guarantee   that   the   rules   will   be   written   by   “masters   of   the

subject.”   United States v. Moore, 95 U.S. 760, 763 (1877).

     In determining whether the Secretary’s interpretation of a

statute is a reasonable one, rather than the best or only one, see

Atlantic Mut. Ins. Co. v. Commissioner, supra, we are not at liberty

to strike down the regulation even if the taxpayer offers a more

attractive statutory interpretation, see United States v. Vogel

Fertilizer Co., 455 U.S. 16, 26 (1982); Brown v. United States, 890

F.2d 1329, 1338 (5th Cir. 1989).

     The parties agree that the standard in National Muffler Dealers

Association, Inc. v. United States, supra at 477,7 is appropriate in




     7
          National Muffler Dealers Association, Inc. v. United
States, 440 U.S. 472, 477 (1979), states, in pertinent part:

          In determining whether a particular regulation
     carries out the congressional mandate in a proper
     manner, we look to see whether the regulation
     harmonizes with the plain language of the statute, its
     origin, and its purpose. A regulation may have
     particular force if it is a substantially
     contemporaneous construction of the statute by those
     presumed to have been aware of congressional intent.
     If the regulation dates from a later period, the manner
     in which it evolved merits inquiry. Other relevant
     considerations are the length of time the regulation
     has been in effect, the reliance placed on it, the
     consistency of the Commissioner’s interpretation, and
     the degree of scrutiny Congress has devoted to the
     regulation during subsequent re-enactments of the
     statute. [Citations omitted.]
                                          - 37 -
this case.         By applying that standard, we hold that the temporary

regulation is valid.           Our holding is based upon the following.

      (1)        The temporary regulation harmonizes8 with the purpose of

the     statute        by   specifically    excluding       intangibles        from    the

definition        of    export   property.       The   purpose    of     the    DISC/FSC

provisions was to increase U.S. exports and U.S. jobs by excluding

from Federal income tax certain property sold by an FSC or a DISC

that was produced, manufactured, or created in the United States.

See Staff of Joint Comm. on Taxation, General Explanation of the Tax

Reform Act of 1976, at 290-291 (J. Comm. Print 1976).                    The temporary

regulation        allows      computer    software     to   be    entitled      to    this

exclusion, as long as the software is not accompanied by a right to

reproduce abroad.

      On the other hand, exporting a computer software master with a

right       to   reproduce     abroad    sends   adaptation,      localization,        and

manufacturing          jobs   offshore.      Thus,     granting    FSC    benefits      to

copyrighted computer software with the right to reproduce abroad

would undermine the basic policy of withholding tax incentives from

export transactions that create manufacturing or production jobs

overseas.




        8
          Petitioner acknowledges that, in the event we hold that
the parenthetical is restricted to motion pictures and sound
recordings (as we have), respondent’s construction of the
temporary regulation harmonizes with the statute’s plain meaning.
                                          - 38 -
       Petitioner claims that because computer software involves a

creative industry where important jobs are performed in the United

States, it belongs in the parenthetical. Respondent posits that the

question is not whether jobs are being performed in the United

States but rather whether jobs that also could be performed in the

United States are moved offshore because copyrights and other

intangibles are exported under license.               We agree with respondent.

       (2)      The temporary regulation reflects Congress’ decision not

to     expand    export        property   treatment   for   intangibles   beyond

copyrights in motion pictures and sound recordings.                The 1976 and

1982     amendments       to     the   DISC   provisions    reflected   Congress’

continuing concern with the cost and revenue effects of the DISC

regime.      Despite pleas from the representatives of the software

industry for a change in the statutory language to include computer

software as export property, section 993(c)(2)(B) was reenacted9 as

section 927(a)(2)(B) without the requested inclusion, apparently on

the basis that the requested change would not be revenue neutral and

that U.S. jobs would be moved offshore.                See TSR, Inc. & Sub. v.

Commissioner, 96 T.C. 903, 916-917 (1991).              Had Congress desired to

make FSC benefits available to computer software copyrights in 1984,



        9
          The 1984 FSC legislation replaced many of the tax rules
that had been applicable to DISCs. DISCs were not abolished;
however, their tax benefits were limited, and an interest charge
on tax-deferred amounts was imposed on DISC shareholders. See
Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 802(b),
98 Stat. 494, 997.
                                       - 39 -
it would have specifically done so.                 See, e.g., Central Bank v.

First Interstate Bank, 511 U.S. 164, 184-188 (1994); United States

v.   Riverside    Bayview     Homes,    Inc.,      474   U.S.   121,    137   (1985).

Congress’ inaction reflects its intent not to grant export property

treatment to computer software copyrights. The temporary regulation

followed Congress’ lead.

       (3)   Congress   was    aware    of   the    temporary    regulation,      its

treatment of computer software, and the debate thereon.                       Congress

had the opportunity to amend the statute in light of the temporary

regulation.      See Perkin-Elmer Corp. & Subs. v. Commissioner, 103

T.C. 464, 480 (1994).         But it did not do so, and the inference of

congressional approval is strong when legislative history contains

some   indication    that     Congress    was      aware   of   and    approved   the

administrative construction.           See Central Bank v. First Interstate

Bank, supra at 184-188.

       (4)   The Commissioner has consistently denied export property

treatment for computer software when accompanied by the right to

reproduce outside the United States.            As early as the comment period

leading up to the issuance of section 1.993-3(f)(3), Income Tax

Regs., and the accompanying technical memorandum, see supra note 6,

software industry representatives sought a regulation that would

include computer software in the parenthetical.                  The Commissioner

considered but rejected the industry’s position, as evidenced by the

omission of computer software from section 1.993-3(f)(3), Income Tax
                                       - 40 -
Regs.        The Commissioner again rejected the industry’s position in

the temporary regulation by explicitly excluding computer software.

        (5)    Invalidating the temporary regulation would eradicate the

need for “copyrights” to appear in section 927(a)(2)(B) because most

copyrights would qualify.         If the parenthetical were to be expanded

so as to be based upon the type of medium on which a copyrighted

work can be mastered, then copyrights in books would qualify.

        In sum, the temporary regulation represents a “reasonable

accommodation        of     the    competing     interests    of    fairness,

administrability, and avoidance of abuse.”            Atlantic Mut. Ins. Co.

Commissioner, 523 U.S. at 383.              We believe that the temporary

regulation is a reasonable and permissible interpretation of section

927(a) and harmonizes with the language, purpose, and legislative

history of the statute.

        4.    Final Matters

        In reaching our conclusions, we have considered all arguments

raised by the parties.        For the sake of completeness, we now discuss

two arguments that heretofore have not been addressed.

        (1)    The parties disagree as to whether the royalties at issue

were paid solely for the exploitation of copyright rights, as

petitioner maintains, or for patents, trademark, and trade secrets,

in   addition      to     copyrights   rights,   as   respondent   maintains.

Petitioner argues that assuming arguendo the royalties it received
                               - 41 -
from the OEM’s and CFC’s were for various types of intellectual

property, the payment for rights other than copyrights was de

minimis.

     In light of our holding above that computer software masters do

not fall within the parenthetical, we conclude that it is not

necessary to decide this issue.

     (2)   Petitioner   maintains   that   we   should   interpret   the

parenthetical in the same manner as the Court of Appeals for the

Ninth Circuit (the court to which an appeal in this case would lie)

interpreted the phrase “books, magazines, periodicals, films, video

tapes, or other matter” for purposes of 18 U.S.C. sec. 2252(a)(4)(B)

in United States v. Lacy, 119 F.3d 742 (9th Cir. 1997).         In that

case, the Court of Appeals interpreted “other matter” as follows:

     “matter” is the physical medium that contains the visual
     depiction–-in this case, the hard drive of Lacy’s computer
     and the disks found in his apartment. * * * “* * * a word
     is understood by the associated words, * * * a general
     term following more specific terms means that the things
     embraced in the general term are the same kind as those
     denoted by the specific terms.” * * * Here, the word
     “matter” appears at the end of the list “books, magazines,
     periodicals, films, [and] video tapes,” all of which are
     physical media capable of containing images. [Citations
     omitted.]

Id. at 748.

     Lacy was a criminal case.      The issue involved therein was

whether an individual computer graphics file is “other matter”

pursuant to 18 U.S.C. sec. 2252(a)(4)(B). The defendant was charged

with possessing child pornography; he had downloaded computerized
                                     - 42 -
visual depictions of child pornography to his computer.         The statute

in question made it a crime to possess “3 or more books, magazines,

periodicals, films, video tapes, or other matter” containing the

offending depictions.          18 U.S.C. 2252(a)(4)(B).      The Court of

Appeals held that because “matter” appeared at the end of a list of

physical     media   capable    of   containing   images,   “other   matter”

containing any visual depiction of a minor engaging in sexually

explicit conduct means a physical medium that contains               visual

depiction.     United States v. Lacy, supra at 748; accord United

States v. McKelvey, 203 F.3d 66 (1st Cir. 2000); see also United

States v. Daury, 215 F.3d 257 (2d Cir. 2000); cf. United States v.

Vig, 167 F.3d 443, 448 (8th Cir. 1999); United States v. Hall, 142

F.3d 988, 999 (7th Cir. 1998).

     Petitioner’s reliance on Lacy is misplaced. Lacy construed

different words, within a different statute, in a different context.

It is irrelevant to the issue before us.

     5.    Conclusion

     Computer software does not come within the purview of the

parenthetical.       Accordingly, we hold that copyrights in computer

software masters are not export property for purposes of determining

section 924 FTGR’s.
                         - 43 -
To reflect the foregoing and the parties’ concessions,



                                   Decision will be entered

                              under Rule 155.
