                                                  GEORGE C. HUFF, PETITIONER v. COMMISSIONER
                                                      OF INTERNAL REVENUE, RESPONDENT

                                                        Docket No. 12942–09.                    Filed August 17, 2010.

                                                 Claiming to be a bona fide resident of the U.S. Virgin
                                               Islands at the close of 2002, 2003, and 2004, and claiming he
                                               was qualified for the gross income tax exclusion provided by
                                               I.R.C. sec. 932(c)(4), P, a U.S. citizen, filed territorial income
                                               tax returns with the Virgin Islands Bureau of Internal Rev-
                                               enue. He did not file Federal income tax returns for those
                                               years. R determined that P was not a bona fide resident of the
                                               Virgin Islands and was not qualified for the gross income tax
                                               exclusion as claimed. Therefore, R issued a notice of deficiency
                                               determining income tax deficiencies and penalties for 2002,
                                               2003, and 2004. For protective reasons, P filed a petition in
                                               this Court but asserts that the deficiency relates to a Virgin
                                               Islands tax matter over which this Court lacks jurisdiction.
                                               Held: Although this case involves putative Virgin Islands
                                               transactions, the notice of deficiency determines deficiencies
                                               in Federal income tax. Whether P satisfies all the require-
                                               ments set forth in I.R.C. sec. 932(c)(4), and thus need not file
                                               a Federal tax return or pay Federal income tax for 2002,
                                               2003, and 2004, is a matter which this Court has jurisdiction
                                               to decide. Held, further, P’s motion to dismiss for lack of juris-
                                               diction will be denied.




                                      222




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                                        William M. Sharp, Lawrence R. Kemm, Joseph A. DiRuzzo,
                                      III, and Marjorie Rawls Roberts, for petitioner.
                                        Daniel N. Price and Ladd Christman Brown, Jr., for
                                      respondent.

                                                                                   OPINION

                                         JACOBS, Judge: This case is before the Court on petitioner’s
                                      motion to dismiss for lack of jurisdiction. The specific ques-
                                      tion to be decided is whether this Court has jurisdiction to
                                      redetermine Federal income tax deficiencies and penalties of
                                      a U.S. citizen who claims (1) to be a bona fide resident of the
                                      U.S. Virgin Islands at the close of each of the years at issue
                                      (i.e., 2002, 2003, and 2004), and (2) to be exempt from U.S.
                                      tax filing and payment requirements as a consequence of his
                                      satisfying all the requirements of section 932(c)(4).
                                         All section references are to the Internal Revenue Code
                                      (Code) in effect for the years at issue unless otherwise
                                      indicated.

                                                                                Background
                                         Petitioner is a U.S. citizen. He resided in Florida when he
                                      filed his petition in this Court on May 28, 2009. Claiming to
                                      be a bona fide resident of the U.S. Virgin Islands (Virgin
                                      Islands) at the close of 2002, 2003, and 2004, petitioner (1)
                                      filed territorial income tax returns with the Virgin Islands
                                      Bureau of Internal Revenue (BIR) for 2002, 2003, and 2004,
                                      and (2) claimed he was qualified for the section 932(c)(4)
                                      gross income exclusion and therefore did not have to file a
                                      Federal income tax return or pay Federal income tax for
                                      those years. Following an audit of petitioner’s 2002, 2003,
                                      and 2004 Virgin Islands income tax returns, on February 27,
                                      2009, respondent issued petitioner a notice of deficiency
                                      determining the following Federal income tax deficiencies
                                      and additions to tax:

                                                                                               Additions to tax

                                                                               Sec.                       Sec.                 Sec.
                                       Year              Deficiency         6651(a)(1)                 6651(a)(2)              6654
                                           2002          $252,687           $55,431.45                 $61,590.50              -0-
                                           2003            88,350            18,586.35                  20,651.50           $2,129.22
                                           2004            77,938            17,271.68                  17,271.68            2,196.05




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                                        Attached to the notice of deficiency was a Form 4549–A,
                                      Income Tax Discrepancy Adjustments, which set forth the
                                      basis for the income tax deficiencies and additions to tax
                                      involved herein:
                                      It is determined that during the taxable years 2002 through 2004 you were
                                      not a bona fide resident of the United States Virgin Islands (USVI). It is
                                      also determined that you participated in a tax avoidance scheme which
                                      involved improperly claiming to be a resident of the USVI and superficially
                                      recasting US-source income as USVI source income in order to inappropri-
                                      ately and invalidly claim a tax credit of 90% under the USVI Economic
                                      Development Program. It has also been determined that all transactions
                                      between NASCO Corporate Finance Consultants, LLC (NASCO) and
                                      American Benefits Institute, Inc. (ABI), Employers International, Inc. (EI),
                                      Professional Advisory Group, Inc. (PAG), and George C. Huff, including
                                      any entity controlled or owned in whole or in part by George C. Huff, are
                                      part of a series of step/sham transactions devoid of economic substance and
                                      will not be recognized for US federal income tax purposes. These step/
                                      sham transactions were part of a larger tax avoidance scheme and were
                                      entered into solely in an attempt to superficially recharacterize US-source
                                      income as USVI-source income in order to inappropriately and invalidly
                                      claim a tax credit of 90% under the USVI Economic Development Program.
                                      See IRS Notice 2004–45.

                                         On May 28, 2009, petitioner filed a petition in this Court.
                                      On April 14, 2010, petitioner filed a complaint petition for
                                      redetermination of income taxes against the Commissioner of
                                      Internal Revenue in the U.S. District Court, District of the
                                      Virgin Islands, St. Thomas and St. John Division (District
                                      Court), case No. 1:10CV00026. On June 1, 2010, petitioner
                                      filed in this Court the motion in question.

                                                                                Discussion
                                      I. The Virgin Islands
                                        The Virgin Islands are an insular area of the United
                                      States; they are a part of neither one of the 50 States nor
                                      the District of Columbia. They are generally treated as a for-
                                      eign country for Federal income tax purposes. See sec.
                                      7701(a)(9).
                                        In 1921 Congress made a predecessor of the Code part of
                                      the internal law of the Virgin Islands. Act of July 12, 1921,
                                      ch. 44, sec. 1, 42 Stat. 123 (codified as amended at 48 U.S.C.
                                      sec. 1397 (2006)).




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                                      This 1921 statute set up the ‘‘mirror tax’’ system that remains in use:
                                      ‘‘Virgin Islands’’ is in effect substituted for ‘‘United States’’ (and vice versa)
                                      in the Internal Revenue Code so that, to satisfy Virgin Islands tax obliga-
                                      tions, an individual or corporation in the Virgin Islands pays taxes to the
                                      BIR equivalent to the taxes an individual or corporation under the same
                                      circumstances in the United States would pay to the Internal Revenue
                                      Service. * * * [Danbury, Inc. v. Olive, 820 F.2d 618, 620 (3d Cir. 1987).]

                                      As the law developed under the mirror tax system, the provi-
                                      sions of the Code have been made applicable to the Virgin
                                      Islands so long as the specific section to be applied is ‘‘ ‘not
                                      manifestly inapplicable or incompatible’ with a separate
                                      territorial income tax’’. Chi. Bridge & Iron Co. v. Wheatley,
                                      430 F.2d 973, 976 (3d Cir. 1970) (quoting Sayre & Co. v.
                                      Riddell, 395 F.2d 407, 410 (9th Cir. 1968)).
                                        The Internal Revenue Service (IRS) implemented the
                                      mirror tax system in 1935. Under the mirror tax system as
                                      implemented, some taxpayers, both business entities and
                                      individuals, were required to file two returns.
                                      For example, a corporation considered ‘‘domestic’’ in the United States but
                                      doing business in the Virgin Islands was required to submit a return to
                                      the BIR, paying tax on income from sources in the Virgin Islands, and to
                                      submit a return to the Internal Revenue Service, paying tax on worldwide
                                      income, with a foreign tax credit allowed for the tax paid to the Virgin
                                      Islands. The mirror system, with its two separate taxing jurisdictions,
                                      operated similarly for citizens of the United States who resided in the
                                      Virgin Islands. * * * [Danbury, Inc. v. Olive, supra at 621.]

                                         The 1954 Revised Organic Act of the Virgin Islands (ROA),
                                      ch. 558, sec. 28, 68 Stat. 508 (1954), modified the administra-
                                      tion of the mirror tax system. ROA sec. 28(a) provided that
                                      the ‘‘proceeds of any taxes levied by the Congress on the
                                      inhabitants of the Virgin Islands * * * shall be covered into
                                      the treasury of the Virgin Islands, and shall be available for
                                      expenditure as the Legislature of the Virgin Islands may pro-
                                      vide’’. The section also provided:
                                      That the term ‘‘inhabitants of the Virgin Islands’’ as used in this section
                                      shall include all persons whose permanent residence is in the Virgin
                                      Islands, and such persons shall satisfy their income tax obligations under
                                      applicable taxing statutes of the United States by paying their tax on
                                      income derived from all sources both within and outside the Virgin Islands
                                      into the treasury of the Virgin Islands * * *. [Id.]

                                        In 1986 the mirror tax system was again modified. Section
                                      932(c)(4), enacted as part of the Tax Reform Act of 1986 (TRA




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                                      1986), Pub. L. 99–514, sec. 1274(a) 100 Stat. 2596, and
                                      amended in 1988, provides the current rules with respect to
                                      the taxation and filing requirements of individuals:
                                      SEC. 932. COORDINATION OF UNITED STATES AND VIRGIN
                                                ISLANDS INCOME TAXES.

                                        (c) TREATMENT OF VIRGIN ISLANDS RESIDENTS.—(1) Application of sub-
                                      section.—This subsection shall apply to an individual for the taxable year
                                      if—
                                             (A) such individual is a bona fide resident of the Virgin Islands at
                                           the close of the taxable year, or
                                             (B) such individual files a joint return for the taxable year with an
                                           individual described in subparagraph (A).
                                           (2) FILING REQUIREMENT.—Each individual to whom this subsection
                                        applies for the taxable year shall file an income tax return for the tax-
                                        able year with the Virgin Islands.

                                                                 *   *   *    *    *   *   *
                                             (4) RESIDENTS OF THE VIRGIN ISLANDS.—In the case of an individual—
                                               (A) who is a bona fide resident of the Virgin Islands at the close of
                                             the taxable year,
                                               (B) who, on his return of income tax to the Virgin Islands, reports
                                             income from all sources and identifies the source of each item shown
                                             on such return, and
                                               (C) who fully pays his tax liability referred to in section 934(a) to
                                             the Virgin Islands with respect to such income,
                                           for purposes of calculating income tax liability to the United States,
                                           gross income shall not include any amount included in gross income on
                                           such return, and allocable deductions and credits shall not be taken into
                                           account.

                                         Thus, an individual who is a bona fide resident of the
                                      Virgin Islands and incurs income tax obligations to both the
                                      United States and the Virgin Islands may satisfy his
                                      reporting and payment requirements by filing only with, and
                                      paying tax only to, the Virgin Islands if he satisfies each of
                                      the three requirements of section 932(c)(4). If the individual
                                      fails to meet any of these requirements, he must file a Fed-
                                      eral income tax return with the IRS. See S. Rept. 100–445,
                                      at 315 (1988). Consequently, an individual failing to satisfy
                                      all three requirements of section 932(c)(4) may be required to
                                      file an income tax return and be liable for taxes in both the
                                      United States and the Virgin Islands.
                                         The term ‘‘bona fide resident of the Virgin Islands’’ is not
                                      defined by the Code. Nor is it given any definition by the
                                      legislative history. Instead, Congress authorized the Sec-




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                                      retary to promulgate regulations for determining Virgin
                                      Islands residency. See TRA 1986 sec. 1274(c), 100 Stat. 2598. 1
                                        A Virgin Islands taxpayer may petition the District Court
                                      to redetermine a Virgin Islands tax deficiency determined by
                                      the BIR in the same manner as a U.S. taxpayer may petition
                                      this Court. Secs. 6212, 6213 (mirror code); V.I. Code Ann. tit.
                                      33, sec. 943 (1994); see WIT Equip. Co. v. Dir., V.I. Bureau
                                      of Internal Revenue, 185 F. Supp. 2d 500, 510 (D.V.I. 2001).
                                      The District Court has ‘‘exclusive jurisdiction over * * * the
                                      income tax laws applicable to the Virgin Islands * * * except
                                      the ancillary laws relating to the income tax enacted by the
                                      legislature of the Virgin Islands.’’ 48 U.S.C. sec. 1612(a)
                                      (2006).
                                      II. The Virgin Islands Economic Development Program
                                         In order to encourage economic development in the Virgin
                                      Islands, Congress has explicitly permitted the Virgin Islands
                                      government to reduce certain taxes. Section 934(b)(1) pro-
                                      vides that the Virgin Islands may reduce taxes on ‘‘income
                                      derived from sources within the Virgin Islands or income
                                      effectively connected with the conduct of a trade or business
                                      within the Virgin Islands.’’
                                         Pursuant to this grant of authority, the Virgin Islands
                                      government enacted several investment incentives, including
                                      the Virgin Islands Industrial Development Program (referred
                                      to by the parties as the economic development program or
                                      EDP), currently codified at V.I. Code Ann. tit. 29, secs. 701–
                                      726 (1998 & Supp. 2010). Intended to promote growth and
                                      the development and diversification of the Virgin Islands’
                                      economy, the EDP granted certain industrial development
                                      benefits to companies that do business in the Virgin Islands.
                                      See V.I. Code Ann. tit. 29, sec. 701 (1998). Participating
                                      companies receive substantial benefits including: A 90-per-
                                      cent exemption on local income taxes, a 90-percent exemption
                                      on the taxation of dividends, and a 100-percent exemption on
                                      gross receipts taxes.
                                         1 For the years at issue, regulations have not been promulgated defining a ‘‘bona fide resident

                                      of the Virgin Islands’’. However, in Notice 2004–45, 2004–2 C.B. 33, 34, the Commissioner states
                                      that the determination turns on the facts and circumstances and the individual’s intentions with
                                      respect to the length and nature of his or her stay in the Virgin Islands, citing sec. 1.934–1(c)(2),
                                      Income Tax Regs., which in turn cites the principles of secs. 1.871–2 through 1.871–5, Income
                                      Tax Regs.




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                                      III. Notice 2004–45
                                         In 2004 the IRS determined that certain tax advisers were
                                      encouraging taxpayers ‘‘to take highly questionable, and in
                                      most cases meritless, positions’’ to claim many of the benefits
                                      of the EDP. To that end, the IRS issued Notice 2004–45, 2004–
                                      2 C.B. 33 (the notice). According to the notice, the following
                                      is a typical scenario used by the promoters of those plans:
                                         Promoters typically approach a taxpayer (Taxpayer) living and working
                                      in the United States and advise Taxpayer to (i) purport to become a USVI
                                      resident by establishing certain contacts with the USVI, (ii) purport to
                                      terminate his or her existing employment relationship with his or her
                                      employer (Employer) and (iii) purport to become a partner of a Virgin
                                      Islands limited liability partnership (V.I.LLP) that is treated as a partner-
                                      ship for U.S. tax purposes. V.I.LLP then purports to enter into a contract
                                      with Employer to provide Employer with substantially the same services
                                      that were provided by Taxpayer prior to the creation of this arrangement.
                                      Typically, after entering into the arrangement, Taxpayer continues to pro-
                                      vide substantially the same services for Employer that he or she provided
                                      before entering into the arrangement, but Taxpayer is nominally a partner
                                      of V.I.LLP instead of an employee of Employer.
                                         Under this arrangement, Employer makes payments to V.I.LLP for Tax-
                                      payer’s services and no longer treats the payments as wages paid to Tax-
                                      payer subject to the withholding and payment of employment taxes and
                                      reporting on Taxpayer’s Form W–2. V.I.LLP, in turn, makes payments to
                                      Taxpayer for his or her services to Employer. V.I.LLP typically treats these
                                      payments for tax accounting purposes either as guaranteed payments for
                                      services or as distributions of Taxpayer’s allocable share of partnership
                                      income. Under this arrangement, the promoter may be a general partner
                                      in V.I.LLP and may retain a percentage of the fees received from
                                      Employer.
                                         V.I.LLP either has or secures a reduction, up to 90 percent, in USVI
                                      income tax liability under the Economic Development Program (EDP) of
                                      the USVI. Taxpayer takes the position that the EDP benefits granted to
                                      V.I.LLP provide a corresponding reduction in the income tax liability that
                                      Taxpayer reports on his or her USVI income tax return with respect to
                                      guaranteed payments from the partnership or distributive shares of the
                                      partnership’s net income, or both. Taxpayer pays tax to the USVI in an
                                      amount approximately equal to 10% of the U.S. income tax liability that
                                      otherwise would be imposed on Taxpayer’s income from performing the
                                      services. Taxpayer claims that, for purposes of computing his or her U.S.
                                      income tax liability, gross income does not include guaranteed payments
                                      received from V.I.LLP or Taxpayer’s distributive share, if any, of the part-
                                      nership’s net income, or both.
                                         [Id., 2004–2 C.B. at 33.]

                                        The IRS stated that the promoters of these plans claim that
                                      (1) individuals who participate in the plan can continue to




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                                      work in the United States and still be a bona fide resident
                                      of the Virgin Islands; (2) Virgin Islands source income
                                      includes income from services performed in the United
                                      States; (3) for purposes of determining the source of income,
                                      the Virgin Islands includes the United States; and (4) non-
                                      Virgin Islands income can be treated as effectively connected
                                      with the conduct of a trade or business within the Virgin
                                      Islands even if under equivalent circumstances that type of
                                      income would not be considered effectively connected with
                                      the conduct of a U.S. trade or business. Respondent deter-
                                      mined that the transactions in which petitioner participated
                                      were the type of transactions discussed in the notice.
                                      IV. Jurisdiction
                                        This Court may exercise jurisdiction only to the extent
                                      authorized by Congress. Naftel v. Commissioner, 85 T.C. 527,
                                      529 (1985). However, the Court has the authority to deter-
                                      mine whether it has jurisdiction over a particular case.
                                      Kluger v. Commissioner, 83 T.C. 309, 314–315 (1984).
                                        We have jurisdiction to redetermine deficiencies in income,
                                      estate, gift, and certain excise taxes when the Commissioner
                                      makes a determination that a deficiency is due, a valid notice
                                      of deficiency is issued with respect to that determination,
                                      and a petition is timely filed in response to the notice of defi-
                                      ciency. See secs. 6211–6215; Kluger v. Commissioner, supra
                                      at 314; Hannan v. Commissioner, 52 T.C. 787, 791 (1969).
                                        Petitioner maintains that the deficiencies relate to a Virgin
                                      Islands tax matter over which this Court lacks jurisdiction.
                                      Petitioner posits that sections 932 and 934, which coordinate
                                      United States and Virgin Islands income taxes, constitute
                                      the tax law of the Virgin Islands and therefore jurisdiction
                                      over the underlying matters properly belongs to the District
                                      Court pursuant to the provisions of 48 U.S.C. sec. 1612 (a).
                                      Continuing, petitioner maintains that inasmuch as 48 U.S.C.
                                      sec. 1612(a) grants ‘‘exclusive’’ jurisdiction to the District
                                      Court with regard to Virgin Islands income tax laws, this
                                      Court lacks jurisdiction because ‘‘Congress was removing all
                                      other courts of any district, jurisdiction, or level from hearing
                                      cases ‘with respect to the income tax laws applicable to the
                                      [USVI].’ 48 U.S.C. §1612.’’ Petitioner maintains that even
                                      though an individual may have both Federal and Virgin




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                                      Islands tax obligations under section 932, this does not affect
                                      the District Court’s jurisdiction. We do not subscribe to peti-
                                      tioner’s position.
                                         U.S. citizens are subject to Federal taxation on their world-
                                      wide income. See Cook v. Tait, 265 U.S. 47, 56 (1924). Gross
                                      income for the purpose of calculating taxable income is
                                      defined as ‘‘all income from whatever source derived.’’ Sec.
                                      61(a). Every individual whose gross income for the taxable
                                      year equals or exceeds a threshold amount is (with enumer-
                                      ated exceptions not applicable here) required to file a Federal
                                      income tax return. Sec. 6012(a)(1)(A).
                                         As a U.S. citizen, petitioner is required to file a Federal
                                      income tax return and use his worldwide gross income to cal-
                                      culate his Federal income tax. Section 932(c) affects the
                                      determination of gross income of an individual subject to
                                      U.S. taxation. If the individual (in this case, petitioner) satis-
                                      fies all three requirements of section 932(c)(4), then the
                                      amount of gross income reported on the individual’s Virgin
                                      Islands tax return (filed under section 932(c)(2)) is not
                                      includable in determining his gross income for purposes of
                                      the Federal income tax. Thus, if the amount of petitioner’s
                                      gross income was that which was reported on his Virgin
                                      Islands tax return, then petitioner’s gross income for pur-
                                      poses of calculating his income tax liability to the United
                                      States would be zero. In such a case, because petitioner
                                      would have no gross income for Federal income tax purposes,
                                      he would not need to file a Federal income tax return. But
                                      if petitioner does not satisfy all three requirements, as
                                      respondent alleges, then for each of the years at issue he will
                                      be required to file a Federal income tax return even if he
                                      filed a Virgin Islands tax return. See sec. 932(a)(2).
                                         Although this case involves putative Virgin Islands trans-
                                      actions, the notice of deficiency determines deficiencies in
                                      petitioner’s Federal income tax. Petitioner filed a timely peti-
                                      tion for redetermination with this Court pursuant to section
                                      6213(a). Whether petitioner satisfies all the requirements
                                      under section 932(c)(4), and thus need not file a Federal tax
                                      return or pay Federal income tax for 2002, 2003, and 2004,
                                      is in dispute and is a matter which this Court has jurisdic-
                                      tion to decide. Because the subject matter herein is within




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                                      the Court’s jurisdiction, we shall deny petitioner’s motion to
                                      dismiss for lack of jurisdiction.
                                                                                 An appropriate order will be issued.

                                                                               f




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