                       107 T.C. No. 10



                UNITED STATES TAX COURT



              SDI NETHERLANDS B.V., f.k.a.
         SDI INTERNATIONAL B.V., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 23747-94.               Filed October 2, 1996.



     P was the licensee of a Bermuda corporation (SDI
Bermuda) of worldwide rights to use computer software.
P in turn licensed those rights for use in the United
States to a U.S. corporation (SDI USA). P received
royalties from SDI USA as well as from other licensees.
P paid specified percentages of the royalties it
received from its licensees to SDI Bermuda. P, SDI
USA, and SDI Bermuda were members of a group of
corporations under common control. Held, the two
licenses were separate and distinct from each other
with the result that the royalties paid to P by SDI USA
did not retain their U.S. source character as part of
the royalties paid by P to SDI Bermuda. Consequently,
they were not income "received from sources within the
United States by" SDI Bermuda within the meaning of
sec. 881 (a), I.R.C., so as to subject P to withholding
tax as provided in secs. 1441(a) and 1442(a), I.R.C.
     Arthur D. Pasternak, Douglas R. Cox, and Jeffrey A. Fiarman,

for petitioner.

     Karen E. Chandler and Kristine A. Roth, for respondent.



                                OPINION


     TANNENWALD, Judge:   Respondent determined deficiencies in

Federal withholding taxes and additions to tax as follows:

                                           Additions to Tax
     Year           Deficiency             Sec. 6651(a)(1)1

     1987            $678,449                  $169,612
     1988             881,067                   220,267
     1989             825,513                   206,378
     1990             641,837                   160,459

     The issue in dispute is whether petitioner, a corporation

organized under the laws of the Kingdom of The Netherlands, is

liable for withholding taxes on royalties paid to a Bermuda

corporation, and additions to tax for failure to file Forms 1042

for each of the years in issue.

     All the facts have been stipulated.   The stipulation of

facts and attached exhibits are incorporated herein by this

reference.




1
   All section references are to the Internal Revenue Code in
effect for the years in issue, and Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 3 -



Background

     Petitioner is a foreign corporation organized in 1974 under

the laws of the Kingdom of The Netherlands.   Petitioner was

formerly known as SDI International B.V. and, prior to that, as

Software Design Dervis B.V.2   Petitioner is the successor in

business to Software Design Sebas B.V., a foreign corporation

organized in 1972 under the laws of the Kingdom of The

Netherlands.

     At the time of filing the petition, petitioner maintained

its principal office in Rotterdam, The Netherlands.

     During the years in issue, petitioner was a member of an

affiliated group of companies (the SDI Group) whose members

designed, manufactured, marketed, and serviced commercial systems

software for use on IBM mainframe computers worldwide.

     SDI Ltd., a corporation organized under the laws of Bermuda,

is the parent company of the SDI Group.   During the years in

issue, petitioner was a wholly owned subsidiary of SDI Antilles,

a Netherlands Antilles corporation, which was a wholly owned

subsidiary of SDI Ltd.

     The SDI Group also included SDI Bermuda Ltd. (SDI Bermuda),

a corporation organized under the laws of Bermuda which, during

the years in issue was a wholly owned subsidiary of SDI Ltd.

2
   Reference to petitioner and other corporations who are members
of the SDI Group herein includes predecessor corporations.
                               - 4 -



     SDI USA, Inc. (SDI USA), a corporation organized under the

laws of the State of California was, during the years at issue, a

wholly owned subsidiary of petitioner.

     Petitioner also had subsidiary corporations in Germany,

France, and the United Kingdom.

     A brochure used by the SDI Group for the years in issue

describes SDI Ltd. as the "Corporate Office" of the SDI Group,

and petitioner, SDI USA and other members of the SDI Group as

"Marketing" offices of the SDI Group.

     SDI Ltd. provided management services to certain of its

direct and indirect subsidiaries for which such subsidiaries paid

it management fees.



Royalty Payments Made By Petitioner

     During the years in issue, petitioner licensed from SDI

Bermuda, pursuant to a license agreement dated November 28, 1986

(Bermuda license agreement), the worldwide rights to certain

commercial systems software for use on IBM mainframe computers

(the software).   The Bermuda license agreement granted petitioner

a nonexclusive license to use or to market the use of, on a

worldwide basis, all of the software and any and all industrial

and intellectual property rights SDI Ltd. had or would acquire
                                - 5 -



from the effective date of the agreement3, in exchange for

certain royalty payments.    The agreement further provided that

petitioner "shall specifically have the right to grant

sublicenses and Agents for the right to use and to market the use

of any and all marketing rights granted to [petitioner] under the

terms" of the agreement.    The agreement was valid for an

indefinite period and could be unilaterally terminated by either

party on 3 months' written notice.

     The Bermuda license agreement contained no express reference

to the United States.

     With respect to royalties, the Bermuda license agreement

provided:

     8.1    The royalties payable to [SDI Bermuda] by [petitioner]
            under this Agreement are fixed at 93% of the net amount
            of all of the royalties due to [petitioner] by all
            persons, entities and institutions which [petitioner]
            sublicensed any of the rights licensed to [petitioner]
            under this Agreement ("Sublicensees"). The
            aforementioned net amount is the amount that remains
            after the deduction of the withholding tax on royalties
            to be withheld when the Sublicensees of [petitioner] or
            Agents of [petitioner] pay the royalties due to the
            [petitioner].

     8.2    The aforementioned percentage of 93% will be increased
            if the net amount of royalties received by [petitioner]
            exceeds * * * in a specific accounting period [the
            following amounts in Dutch florins]:


3
   The record does not explain how or from whom SDI Ltd., known
in l986 as Castle Investments Ltd., acquired its existing rights,
but it is clear that at least some of them had been previously
owned by petitioner's predecessor.
                                     - 6 -



     If [Petitioner's]               but not              Then the Percentage
     royalty receipts                                     for that portion to
     exceed:                                              be paid on will be:

           Dfl                            Dfl                    Percent

      2.000.000,=                    4.000.000,=                    94

      4.000.000,=                    6.000.000,=                    95

      6.000.000,=                    8.000.000,=                    96

      8.000.000,=                   10.000.000,=                    97

     10.000.000,=                                                   98

                        *   *   *     *      *   *   *

     8.3 All royalties payable to [SDI Bermuda] under this
     Agreement shall be due within 28 days from the moment that
     the royalties to be paid by the Sublicensees shall be due to
     [petitioner]. All royalties payable to [SDI Bermuda] under
     this Agreement, will be paid by [petitioner] at the option
     of the [petitioner], in the same currency or in U.S. Dollars
     in which the royalties due to [petitioner] are payable.

     8.4   [Petitioner] shall annually provide [SDI Bermuda] with
           a survey of all royalties due by the Sub-licensees and
           pay [SDI Bermuda] in accordance with subsection 8.1
           hereof. Any additional payments due to [SDI Bermuda]
           pursuant to subsection 8.2 shall be made immediately
           after the approval of the annual accounts of
           [petitioner]. [SDI Bermuda] has the right to have a
           representative examine [petitioner's] accounts.

     Petitioner made royalty payments to SDI Bermuda, pursuant to

the Bermuda license agreement, during the years in issue, in the

following amounts:

                 1987                        $3,583,983
                 1988                         5,104,781
                 1989                         5,146,862
                 1990                         4,768,349
                                 - 7 -



     The above payments constituted the following percentages of

the total worldwide royalty payments received by petitioner with

respect to the software:

                                               Total Royalty
          Year             Percentage        Payments Received

          1987                93.89               $3,817,182
          1988                95.94                5,320,816
          1989                94.93                5,421,908
          1990                95.60                4,987,662



Royalty Payments Received by Petitioner from SDI USA

     During the years in issue, petitioner was a party to an

exclusive license agreement with SDI USA, dated October 1, 1972,

and as modified from time to time, regarding the use and

licensing of the software in the United States (the U.S. license

agreement).4   SDI USA was responsible for the direct marketing

and sales of the software in the United States.

     The U.S. license agreement provided in part:

          2.1 In consideration for the payment of the
     royalties provided hereunder and the performance of the
     other terms and conditions hereof by [SDI USA],
     [petitioner] hereby grants and transfers to [SDI USA],
     upon the terms and subject to the conditions
     hereinafter set forth, the exclusive right and license
     during the Term hereof, to have disclosed to it by
     [petitioner] and to exploit, use and lease and
     otherwise obtain the benefit of [the software] within
     the Territory.

4
   At the time this agreement was executed, petitioner was known
as Software Design Sebas B.V. (later known as Software Design
Dervis B.V.), and SDI USA was known as Software Design, Inc.
                                - 8 -



          2.2 This Exclusive License shall include, (i) the
     right to sublicense to others the use and lease of [the
     software] within the Territory, subject, however, to
     the terms and conditions of this License; and (ii) this
     License shall also include the right and, as
     hereinafter provided, the obligation of [SDI USA], to
     provide or to provide for the exclusive maintenance,
     servicing and repair of [the software] within the
     Territory. * * *

                    *   *   *    *      *   *   *

          2.4 The Territory of this License shall mean and
     be restricted to the continental United States, Hawaii
     and Alaska.

     Petitioner agreed not to license the software for use or to

compete directly or indirectly with SDI USA's exploitation of the

software in the United States during the term of its license to

SDI USA.5

     Until February 1987, the agreement provided that SDI USA

would pay to petitioner "an annual royalty equal to fifty percent

(50%) of the annual gross revenues of [SDI USA] from leasing and

sublicensing of [the software], without any deductions therefrom

except rebates, discounts and sales or value added taxes."

     The U.S. license agreement was modified in February 1987 to

provide that SDI USA would pay petitioner "a royalty equal to

(50%) fifty percent of the gross billable or invoiced revenues of

[SDI USA] with regard to all products licensed herein or further

5
   In l986, these rights became exclusive only as between
petitioner and SDI USA and were otherwise subject to the
nonexclusive worldwide rights that petitioner acquired at that
time.
                               - 9 -



licensed in the future, without any deductions therefrom except

rebates, or, sales or value added taxes."

     Petitioner received royalty payments pursuant to the U.S.

license agreement from SDI USA, during the years in issue, in the

following amounts:

                1987                   $2,663,401
                1988                    2,936,889
                1989                    3,092,710
                1990                    2,139,458

     Respondent mailed notices of deficiency to petitioner, one

for 1987, 1988, and 1989, and one for 1990, on July 29, 1994.

           The parties have stipulated the amounts of royalties

received by petitioner from SDI USA and paid by petitioner to SDI

Bermuda.   As a consequence, it appears that these amounts, if

subject to withholding tax, would produce deficiencies greater

than those determined in the notices of deficiency for 1987,

1988, and 1990 and a lesser amount for 1989.        Respondent has made

no specific request for any increased deficiencies.

                            Discussion

Increased Deficiencies

     Section 6214(a) provides that this Court has jurisdiction to

determine an increased deficiency "if claim therefor is asserted

* * * at or before the hearing or a rehearing".       Under the

circumstances herein, where the amounts upon which the

mathematical calculation of the withholding tax is based have
                               - 10 -



been stipulated by the parties and where the issue upon which the

liability for both the original and the increased deficiencies

depends is the same, we think that respondent has made a timely

claim for the increased deficiencies and see no reason to

preclude our consideration of such increases.   See Pallottini v.

Commissioner, 90 T.C. 498, 500 (1988); cf. Law v. Commissioner,

84 T.C. 985, 989 (1984).6   Indeed, as we understand petitioner's

position, it does not oppose such consideration except in the

context of its contention that the burden of proof should in any

event be shifted to respondent under Rule 142(a).

Burden of Proof

      Petitioner argues that the notices of deficiency refer only

to section 1441, so that reliance by respondent on section 1442

constitutes a new matter on which respondent has the burden of

proof under Rule 142(a).    That burden of proof would, according

to petitioner, require respondent to prove that, during the years

in issue, SDI Bermuda was not engaged in a trade or business

within the United States or, if so engaged, that the royalties

received from petitioner by SDI Bermuda were not effectively

connected with such trade or business7; if SDI Bermuda were so

6
   See also Brown v. Commissioner, T.C. Memo. 1996-325; cf.
Wicker v. Commissioner, T.C. Memo. 1993-431, affd. without
published opinion 50 F.3d 12 (8th Cir. 1995).
7
    Petitioner makes a further reference to placing the burden of
                                                    (continued...)
                              - 11 -



engaged and the royalties so connected, no withholding would be

necessary.8   See secs. 1441(c), 1442(a) and (b), 881(a); secs.

1.1442-2, 1.1441-4, Income Tax Regs.

     Initially, we deal with petitioner's position in respect of

the burden of proof without regard to the increases in

deficiencies for 1987, 1988, and 1990.   In this connection, we

note that the fact that the case has been fully stipulated does

not alter the application of the burden of proof rules.   Rule

122(b); Borchers v. Commissioner, 95 T.C. 82, 91 (1990), affd. on

other grounds 943 F.2d 22 (8th Cir. 1991).

     In Zarin v. Commissioner, 92 T.C. 1084, 1088-1089 (1989),

revd. on other grounds 916 F.2d 110 (3d Cir. 1990), we set forth

the following frame of reference for determining what is new

matter within the meaning of Rule 142(a):

          Rule 142(a) provides that the burden of proof is
     on petitioner, "except that, in respect of any new
     matter, increases in deficiency, and affirmative
     defenses, pleaded in his answer, it shall be upon the
     respondent." A new position taken by respondent is not
     necessarily a "new matter" if it merely clarifies or

7
 (...continued)
proof on respondent in respect of the absence of income from
insurance includable under sec. 842, a reference which, under the
circumstances herein, we think is irrelevant.
8
   We also note that, for purposes of this proceeding, respondent
does not contend that petitioner maintained an office or place of
business in the United States, engaged in trade or business
within the United States, or received income effectively
connected with the conduct of a trade or business within the
United States.
                             - 12 -



     develops respondent's original determination without
     requiring the presentation of different evidence, being
     inconsistent with respondent's original determination,
     or increasing the amount of the deficiency. Achiro v.
     Commissioner, 77 T.C. 881, 889-891 (1981).

     The notices of deficiency herein provide in pertinent part:

     The payments you made to nonresident aliens in the
     amounts shown are subject to the withholding rate
     provided by section 1441(a) of the Internal Revenue
     Code. Since you did not withhold the tax, and did not
     establish that the recipient of the payments paid the
     United States tax, you are liable for the tax that
     should have been withheld. * * *

     We think that section 1441, which imposes the withholding

tax on nonresident alien individuals and foreign partnerships,

was cited only for the rate of tax applied by respondent.

Respondent cited no section for the source of the deficiencies,

nor, indeed, was respondent required to do so.    Jarvis v.

Commissioner, 78 T.C. 646, 655-656 (1982).   The language of the

notices did not, directly or by necessary inference, exclude a

claim under section 1442, which imposes the withholding tax on

foreign corporations and upon which respondent proceeds herein.

Moreover, section 1442 makes reference to and incorporates

section 1441 so that reference to section 1441 is entirely

appropriate in a proceeding under section 1442.   See Central de

Gas de Chihuahua, S.A. v. Commissioner, 102 T.C. 515, 517 (1994).

Beyond this, the very elements of section 1442 upon which

petitioner relies to shift to respondent the burden of proof,

i.e., the burden of proving that SDI Bermuda was not engaged in
                               - 13 -



trade or business within the United States or, if so engaged,

that the royalties were not effectively connected with such trade

or business, are also present in the application of section 1441.

See also secs. 1.1442-2 and 1.1441-4, Income Tax Regs.    Compare

sec. 1442(b)9 with sec. 1441(c)10.   Thus, there is no

inconsistency in applying section 1442 rather than section 1441

herein since similar evidence is involved in providing a basis

for determining whether or not a taxpayer is exempt from

withholding under either section.    Inconsistency and the absence

of a need for different evidence are critical elements in

9
     Sec. 1442(b) provides:

            (b) Exemption.--Subject to such terms and
       conditions as may be provided by regulations prescribed
       by the Secretary, subsection (a) shall not apply in the
       case of a foreign corporation engaged in trade or
       business within the United States if the Secretary
       determines that the requirements of subsection (a)
       impose an undue administrative burden and that the
       collection of the tax imposed by section 881 on such
       corporation will not be jeopardized by the exemption.


10
     Sec. 1441(c) provides:

            (c)  Exceptions.--
                 (1) Income connected with United States
            business.--No deduction or withholding under
            subsection (a) shall be required in the case of
            any item of income (other than compensation for
            personal services) which is effectively connected
            with the conduct of a trade or business within the
            United States and which is included in the gross
            income of the recipient under section 871(b)(2)
            for the taxable year.
                              - 14 -



deciding whether a "new matter" is involved that requires that

the burden of proof be shifted to respondent.   See Zarin v.

Commissioner, supra; Estate of Emerson v. Commissioner, 67 T.C.

612, 620 (1977).

     Finally, we note that petitioner itself contributed to any

confusion that may have existed in respect of the applicability

of section 1442 or section 1441, referred to in the notices of

deficiency.   Prior to the time the notices of deficiency were

prepared, respondent had received limited information regarding

the royalty payments at issue.   In particular, it was unclear to

whom, and in what amount, the royalty payments were being made.

Only just prior to the date set for trial and after prodding by

the Court did petitioner come forth with evidence as to whom and

in what amounts the royalties were paid.

     In sum, since the essential elements of proof are the same

under the circumstances herein whether section 1441 or section

1442 provides the key to decision, there is no surprise or

unfairness in rejecting petitioner's contention that the burden

of proof should be shifted to respondent.   See Stewart v.

Commissioner, 714 F.2d 977, 990-991 (9th Cir. 1983), affg. T.C.

Memo. 1982-209.11

Liability for Withholding

11
   See also Ruark v. Commissioner, T.C. Memo. 1969-48, affd. per
curiam 449 F.2d 311 (9th Cir. 1971).
                               - 15 -



     Section 881(a) provides that a 30-percent tax shall be

imposed on "the amount received from sources within the United

States by a foreign corporation" falling within certain

categories of income.12   Section 1442 provides a method for

collecting that tax.   Central de Gas de Chihuahua, S.A. v.

Commissioner, 102 T.C. at 519.

     Section 1442 provides in part:

          (a) General Rule.-- In the case of foreign
     corporations subject to taxation under this subtitle,
     there shall be deducted and withheld at the source in
     the same manner and on the same items of income as is
     provided in section 1441 a tax equal to 30 percent
     thereof. * * *

     Royalties are among the types of income included in section

1441(b).   Sec. 1.1441-2(a), Income Tax Regs.; see also sec.

1.881-2(b), Income Tax Regs.    In addition, section 861(a)(4)

provides that U.S. source income includes:

          (4) Rentals and Royalties.--Rentals or royalties
     from property located in the United States or from any
     interest in such property, including rentals or
     royalties for the use of or for the privilege of using
     in the United States patents, copyrights, secret
     processes and formulas, good will, trade-marks, trade
     brands, franchises, and other like property.

     Section 1441(a) completes the picture of the statutory

provisions involved herein.    It provides:



12
   A "foreign" corporation is a corporation that is not created
or organized in the United States or under the law of the United
States or of any State. Sec. 7701(a)(4) and (5).
                              - 16 -



     all persons * * * having the control, receipt, custody,
     disposal, or payment of any of the items of income
     specified in subsection (b) [which includes
     "royalties"] (to the extent that any of such items
     constitutes gross income from sources within the United
     States), of any nonresident alien individual or of any
     foreign partnership shall * * * deduct and withhold
     from such items a tax equal to 30 percent thereof * * *

     There can be no dispute that the royalty payments received

by petitioner from SDI USA constitute U.S. source income and were

received by petitioner as such within the meaning of section

1442(a).   See Commissioner v. Wodehouse, 337 U.S. 369 (1949); see

also Estate of Marton v. Commissioner, 47 B.T.A. 184 (1942).

However, royalties paid by SDI USA to petitioner are exempt from

taxation by virtue of section 894 and article IX of the United

States-Netherlands Income Tax Convention, April 29, 1948, 62

Stat. 1757, 1762, 1950-1 C.B. 92, as amended by the Supplementary

Protocol, June 15, 1955, 6 U.S.T. 3696, 1956-2 C.B. 1116, and as

further amended by the United States-Netherlands Supplementary

Income Tax Convention, Dec. 30, 1965, 17 U.S.T. 896, 1967-2 C.B.

472 (U.S.-Netherlands treaty); see also sec. 894.   There is no

comparable U.S. treaty exemption that would apply to royalty

payments from petitioner to SDI Bermuda.

     The parties have locked horns on several aspects of the

application of the statutory provisions in light of the impact of

the U.S.-Netherlands treaty exemption:   (1) Whether the royalties

paid by petitioner to SDI Bermuda constitute income "received
                             - 17 -



from sources within the United States by" SDI Bermuda and are

thus subject to withholding under section 1441(a); (2) whether

petitioner can be considered a "withholding agent"; (3) whether

there is a limitations period that has expired in respect of

respondent's right to assess a deficiency in withholding tax

against petitioner; and (4) whether petitioner is liable for

additions to tax under section 6651(a)(1) for failure to file

withholding tax returns.

     For reasons hereinafter set forth, we resolve the first

issue in petitioner's favor with the result that it is

unnecessary for us to address the remaining issues.13    Before

proceeding with our analysis of the first issue, however, it is

important to note that respondent does not question the existence

of petitioner as a valid Netherlands corporation or the

application of the treaty exemption insofar as the payments by

SDI USA to petitioner are concerned.   Similarly, respondent does

not attack the arrangements under which petitioner had a license

of the worldwide rights and SDI USA had a license of the U.S.

rights, although respondent does ask us to take into account the


13
   Similarly we have no need to decide further whether any
elements of proof should be placed on respondent under Rule
142(a) with respect of the increases in the deficiencies for
1987, 1988, and 1990 or whether any such burden should be applied
on an overall or year by year basis. See Zarin v. Commissioner,
92 T.C. 1084, 1089 (1989), revd. on other grounds 916 F.2d 110
(3d Cir. 1990).
                             - 18 -



close relationship of the various corporations involved.     Compare

Gaw v. Commissioner, T.C. Memo. 1995-531, on appeal (D.C. Cir.,

May 20, l996).

      Rather, respondent focuses her argument solely on the

proposition that, since the royalties paid by SDI USA to

petitioner were U.S. source income, they retained that character

as part of the royalties paid by petitioner to SDI Bermuda and,

as a matter of law, constitute income "received from sources

within the United States by" SDI Bermuda under section 881(a).14

Respondent contends that the fact that such royalties were

combined with non-U.S. source royalties received by petitioner to

determine the amount of royalties payable by petitioner to SDI

Bermuda does not preclude the tracing of the royalties received

by petitioner from SDI USA to U.S. sources.   To implement such

tracing, respondent simply applies the percentage specified in

the worldwide license agreement between petitioner and SDI

Bermuda and utilized in computing the amount of the required

payment by petitioner to SDI Bermuda.   To support her contention

that such an allocation is permissible, respondent cites

Wodehouse v. Commissioner, 15 T.C. 799 (1950); Rohmer v.

Commissioner, 14 T.C. 1467 (1950); Rohmer v. Commissioner, 5 T.C.


14
   At no time has respondent contended that petitioner has
failed to carry its burden of proof in respect of the factual
foundations of this legal issue.
                              - 19 -



183 (1945), affd. 153 F.2d 61 (2d Cir. 1946); Estate of Marton v.

Commissioner, 47 B.T.A. 184 (1942); Molnar v. Commissioner, 156

F.2d 924 (2d Cir. 1946), affg. a Memorandum Opinion of this

Court.   In all of these cases, however, the payments, upon which

a withholding tax was imposed, were directly from a U.S. payor

and the U.S. withholding tax was imposed on that payor.   None of

them address the situation involved herein, where there is a

second licensing step under which royalties are being paid and

upon which the U.S. withholding tax is sought to be imposed.

Thus, these cases provide no guidance in respect of whether the

U.S. source characterization of the royalties paid by SDI USA to

petitioner flows through to the royalties paid by petitioner to

SDI Bermuda.

     Petitioner argues that the royalties paid by SDI USA to

petitioner and exempt from tax under the Netherlands treaty

became merged with the other royalties received by petitioner

from non-U.S. sources and consequently lost their character as

U.S. source income.   Petitioner submits that, while the royalty

payments from SDI USA may be U.S. source income, its royalty

payments to SDI Bermuda were made on a separate and independent

basis.   With respect to the payments to SDI Bermuda, petitioner

contends that they were made pursuant to a worldwide licensing

agreement between two foreign corporations, and as such do not

constitute income "received from sources within the United
                                - 20 -



States" so that no withholding is required under section 1442(a).

     Pertinent authority on the issue before us is sparse.

Indeed respondent relies solely on Rev. Rul. 80-362, 1980-2 C.B.

208, for her "flow-through" position.    In Rev. Rul. 80-362, A, a

resident of a country other than the United States and The

Netherlands, licensed the rights to a U.S. patent to X, a

Netherlands corporation.   X agreed to pay a fixed royalty each

year to A.   X relicenses those rights to Y, a U.S. corporation,

for use in the United States.    In ruling that X was liable for a

withholding tax under section 1441, the ruling states:

           In the present factual situation, the royalties
     from Y to X are exempt from United States tax under
     Article IX(1) of the Convention. However, the royalties
     from X to A are not exempt from taxation by the United
     States because there is no income tax convention
     between A's country of residence and the United States
     providing for such an exemption. Since the royalties
     from X to A are paid in consideration for the privilege
     of using a patent in the United States, they are
     treated as income from sources within the United States
     under section 861(a)(4) of the Code and are subject to
     United States income taxation under section
     871(a)(1)(A). [Rev. Rul. 80-362, 1980-2 C.B. at 208-
     209.]

     We are not persuaded that Rev. Rul. 80-362, supra, provides

any significant support for respondent's position herein.    It

fails to reflect any reasoning or supporting legal authority.

This circumstance is particularly relevant in applying the usual

rule that, in any event, revenue rulings are not entitled to any

special deference.   See Northern Indiana Public Service Co. v.
                              - 21 -



Commissioner, 105 T.C. 341, 350 (1995), on appeal (7th Cir.,

March 13 and 25, 1996); Halliburton Co. v. Commissioner, 100 T.C.

216, 232 (1993), affd. without published opinion 25 F.3d 1043

(5th Cir. 1994).

     At this point, we note that respondent has not argued that

petitioner was a mere conduit or agent of SDI USA in paying

royalties to SDI Bermuda or that SDI Bermuda was the beneficial

owner of the royalties petitioner received from SDI USA so that

the U.S.-Netherlands treaty exemption should not apply.   Compare

Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 (1971), with

Northern Indiana Public Service Co. v. Commissioner, supra; cf.

Estate of Petschek v. Commissioner, 81 T.C. 260 (1983), affd. 738

F.2d 67 (2d Cir. 1984).   Presumably such an argument would have

produced a situation where SDI USA rather than petitioner would

have been targeted by respondent as the taxpayer liable for the

withholding tax under section 1442(a).15   See Northern Indiana

Public Service Co. v. Commissioner, 105 T.C. at 347.

     Although Aiken Industries, Inc. v. Commissioner, supra, and

Northern Indiana Public Service Co. v. Commissioner, supra,

15
   Given the basis for our disposition of this case, we have no
need to deal with the question whether petitioner, even though
only a conduit, would meet the statutory requirements of a
withholding agent. See sec. 1.1441-7, Income Tax Regs., which
provides that a foreign corporation can be a withholding agent.
See also Fides v. Commissioner, 137 F.2d 731 (4th Cir. 1943),
affg. 47 B.T.A. 280 (1942); Gaw v. Commissioner, T.C. Memo. 1995-
531, on appeal (D.C. Cir., May 20, 1996).
                             - 22 -



involved the conduit concept, we think they provide some guidance

for our disposition of the instant case.    We take this view

because the flow-through characterization concept is, in a very

real sense, the conduit concept albeit in a somewhat different

garb, i.e., whether the U.S. source income is being received as

such, because of the status of the paying entity in one case, and

the status of the subject matter of the payment in the other.

     In Aiken Industries, Inc. v. Commissioner, supra, back-to-

back loans, in the identical amounts of principal and rates of

interest, were made between a U.S. corporation and a related

corporation organized under the laws of the Republic of Honduras,

and between the Honduran corporation and its indirect parent.

Respondent argued that the Honduran corporation should be

disregarded for tax purposes, and that the parent corporation

should be deemed the true owner and recipient of the interest

payment from the U.S. corporation.    We held the Honduran

corporation to be a mere conduit for the passage of interest

payments and imposed withholding tax liability on the U.S.

corporation.

     In Northern Indiana Public Service Co. v. Commissioner,

supra, the taxpayer, a domestic corporation, organized a finance

subsidiary incorporated in Curacao under the Commercial Code of

the Netherlands Antilles, (to which the U.S.-Netherlands treaty

applied) for the purpose of issuing notes in the Eurobond market.
                                - 23 -



The finance subsidiary borrowed $70 million at 17-1/4 percent

interest in that market and lent that amount to the taxpayer at

18-1/4 percent interest.   Respondent argued that the finance

subsidiary should be ignored and that the taxpayer was liable for

withholding taxes under section 1441 on the interest payments to

the foreign Eurobond holders.    Finding that the finance

subsidiary engaged in substantive business activity that resulted

in significant earnings, we held that the finance subsidiary was

not a mere conduit or agent.

     We think the within situation falls more within the ambit of

Northern Indiana than Aiken Industries.    In the latter case,

there was an identity both in terms and timing between the back

to back loans, as well as a close relationship between the

parties involved.   In the former case, although there was a clear

connecting purpose between the borrowing and lending

transactions, i.e., to obtain the benefit of the exemption from

the withholding tax on interest under the U.S.-Netherlands

treaty; there were differences in terms, i.e., in the interest

rate (albeit not large); and a close relationship between all the

parties was not present since the borrowings by the finance

subsidiary were from unrelated parties.

     In the instant case, there was a close relationship between

the parties.   However, although respondent asks us, in passing,

to take that relationship into account, she does not pursue the
                               - 24 -



matter to the point where she contends that it is a significant

factor.    Given the fact that respondent recognizes the existence

of all of the parties as valid corporate entities and does not

attack the bona fides of the license agreements between SDI USA

and petitioner, on the one hand, or petitioner and SDI Bermuda,

on the other, we are not disposed to allow the close relationship

element to control our decision.

       The facts of the matter are that the two license agreements

had separate and distinct terms and that petitioner had an

independent role as the licensee from SDI Bermuda and the

licensor of the other entities, including but not limited to SDI

USA.    The schedules of royalty payments provided for a spread,

not unlike the spread involved in Northern Indiana, which

compensated petitioner for its efforts.    Like the finance

subsidiary in Northern Indiana, petitioner engaged in licensing

activities from which it realized substantial earnings.    In fact,

on a percentage basis, it earned between 5 and 6 percent,

compared to the 1 percent earned by that finance subsidiary in

Northern Indiana.16   Under the circumstances herein, we think

these arrangements should be accorded separate status with the

result that, although the royalties paid by petitioner to SDI


16
   In dollar amounts, petitioner retained net royalties in the
amounts of $233,199 in 1987, $216,035 in 1988, $275,046 in 1989,
and $219,313 in 1990.
                              - 25 -



Bermuda were derived from the royalties received by petitioner

from SDI USA, they were separate payments.

     We find support for our conclusion herein in that

respondent's view of the law could cause a cascading royalty

problem, whereby multiple withholding taxes could be paid on the

same royalty payment as it is transferred up a chain of

licensors.   See, e.g., 1 Isenbergh, International Taxation: U.S.

Taxation of Foreign Persons and Foreign Income, par. 7.8, pp.

7:20-7:21 (2d ed. 1996); 2 Kuntz and Peroni, U.S. International

Taxation C1-45 - C1-46 (1992); Dale, "Withholding Tax on Payments

to Foreign Persons," 36 Tax L. Rev. 49, 66-67 (1980).    But for

the U.S.-Netherlands treaty, the royalty payments from SDI USA

could be subject to withholding tax twice under respondent's

reasoning herein.

     Respondent argues that only one withholding tax is being

sought herein.   However, this ignores the fact that, by treaty,

the U.S. agreed to forgo taxing royalties and to allow them to be

taxed by The Netherlands.   Whether or not The Netherlands

actually taxed the royalties is irrelevant.

     Respondent also infers that she would use her discretion not

to apply more than one level of withholding tax on multiple

transfers of income that originated as U.S. source income.    We

think this places an improper exercise of discretion in

respondent's hands.   To avoid the imposition of interest and
                              - 26 -



additions to tax as determined by respondent herein, each payor

in the chain might well feel compelled to file returns and pay

withholding taxes.   See Glicklich, "Final Regulations on Conduit

Financing Arrangements Empower the IRS", 84 J. Taxn. 5, 12

(1996).   We are not disposed to conclude, in the absence of any

legislative expression on the subject, that Congress intended the

statutory provisions to permit "cascading" with the question of

relief left to the mercy of respondent.

     We hold that the payments by petitioner with respect to

which respondent seeks to impose liability for the 30 percent

withholding tax herein were not "received from sources within the

United States by" SDI Bermuda under sections 881(a), 1441(a), and

1442(a).17



                                    Decision will be entered

                               for petitioner.




17
   We note that changes in the U.S.-Netherlands treaty,
applicable to years subsequent to the years before us, may
provide a different framework for disposing of this issue.
Convention for the Avoidance of Double Taxation, U.S.-Neth.,
Dec. 18, 1992, Tax Treaties (CCH) par. 6103.01, as amended by
Supplementary Protocol, Oct. 13, 1993, Tax Treaties (CCH) par.
6116.
