                         T.C. Memo. 2000-393



                       UNITED STATES TAX COURT



         JACOB AND CHANA PINSON, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket Nos.    7561-98,     7562-98,   Filed December 28, 2000.
                    7563-98,     7564-98,
                    7565-98,     7566-98,
                    7567-98,    19353-98,
                   19354-98,    19355-98,
                   19356-98,    19357-98,
                   19358-98,    19359-98.



     1
        Cases of the following petitioners are consolidated
herewith: B. Mayer and Ella Zeiler, docket No. 7562-98; Joseph
and Sara Deitsch, docket No. 7563-98; Joshua and Rachel Sandman,
docket No. 7564-98; Deitsch Plastic Company, Inc., docket No.
7565-98; Mordecai and Bonnie Deitsch, docket No. 7566-98; David
and Sara Deitsch, docket No. 7567-98; B. Mayer and Ella Zeiler,
docket No. 19353-98; Mordecai and Bonnie Deitsch, docket No.
19354-98; Deitsch Plastic Company, Inc., docket No. 19355-98;
Joshua and Rachel Sandman, docket No. 19356-98; David and Sara
Deitsch, docket No. 19357-98; Jacob and Chana Pinson, docket No.
19358-98; Joseph and Sara Deitsch, docket No. 19359-98.

     * This opinion supplements our previously filed Memorandum
Opinion in Pinson v. Commissioner, T.C. Memo. 2000-208.
                                 - 2 -

     Robert J. Percy, Bruce I. Judelson, Richard A. Levine,2

Mortimer M. Caplin,3 Richard E. Timbie,3 and Christopher S.

Rizek,3 for petitioners.

     Stephen C. Best and Bradford A. Johnson, for respondent.



                    SUPPLEMENTAL MEMORANDUM OPINION

     NIMS, Judge:    On July 6, 2000, the Court filed its opinion

in this case, T.C. Memo. 2000-208, in which we disallowed

petitioners’ claimed foreign tax credits.    We further held that

petitioners could not reserve the right, as part of a Rule 155

computation, to elect to take deductions for foreign taxes in

lieu of the disallowed foreign tax credits.    This issue, raised

for the first time on brief in only the most summary fashion, had

not previously been addressed through the pleadings or at trial

and was therefore deemed untimely.

     Subsequently, in August of 2000, a motion for

reconsideration and separate motions to amend were filed wherein

certain of petitioners moved for reconsideration of that portion




     2
       Richard A. Levine has entered an appearance as counsel for
petitioners at docket Nos. 7561-98, 7563-98, 7564-98, 7567-98,
19356-98, 19357-98, 19358-98, and 19359-98.
     3
       Mortimer M. Caplin, Richard E. Timbie, and Christopher S.
Rizek have each entered an appearance as counsel for petitioners
at docket Nos. 7561-98, 7563-98, 7564-98, 7565-98, 7566-98, 7567-
98, 19354-98, 19355-98, 19356-98, 19357-98, 19358-98, and 19359-
98.
                                 - 3 -

of the Court’s opinion relating to the deductions and for leave

to amend their respective petitions in order to place the

deduction issue properly before the Court.

     Petitioners at docket Nos. 7561-98, 7563-98, 7564-98, and

7567-98 seek to amend their petitions by adding the following

paragraph:

          8. Petitioners are entitled to claim a deduction
     for the foreign income taxes they paid to the State of
     Israel in 1991 ($296,554) and 1992 ($704,450) pursuant
     to Treasury Regulation §1.901-1 in the event any of the
     paid taxes are not allowed as a credit under Sections
     901-908.

     Similarly, petitioners at docket Nos. 19356-98, 19357-98,

19358-98, and 19359-98 seek to amend their respective petitions

by adding the following paragraph:

          8. Petitioners are entitled to claim a deduction
     for the foreign income taxes they paid to the State of
     Israel in 1994 ($291,695) pursuant to Treasury
     Regulation §1.901-1 in the event any of the paid taxes
     are not allowed as a credit under Sections 901-908.

     On September 12, 2000, respondent filed notices of objection

to petitioners’ motions.   Petitioners then responded thereto with

filings on September 26, 2000.    Upon receipt of these

submissions, the Court directed by an order dated October 5,

2000, that the parties file memoranda of law addressing certain

procedural issues raised by the motions.

     In the ensuing interval, on October 10, 2000, respondent

filed a motion for reconsideration asking the Court to clarify

its analysis of petitioners’ reporting on their Forms 1116,
                               - 4 -

Foreign Tax Credit, of payments received from Flocktex

Industries, Ltd. (FIL).   Petitioners were then by order given an

opportunity to submit any objections to this motion.   The

memoranda relating to petitioners’ motions and petitioners’

response to respondent’s motion were thereafter received and

filed in November of 2000.   This supplemental opinion addresses

these various motions.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.   The term “petitioners” is used herein to

refer to those petitioners asking for relief by means of the

subject motions and related filings.

I.   Petitioners’ Motions To Amend and for Reconsideration

     We begin with petitioners’ motions to amend and for

reconsideration.   Rule 41(a) provides in effect that after the

pleadings are closed, “a party may amend a pleading only by leave

of Court or by written consent of the adverse party, and leave

shall be given freely when justice so requires.”   Like rule 15(a)

of the Federal Rules of Civil Procedure, from which it is

derived, Rule 41(a) reflects “a liberal attitude toward amendment
                               - 5 -

of pleadings.”   60 T.C. 1089 (explanatory note accompanying

promulgation of Rule 41).   The U.S. Supreme Court has interpreted

the “freely given” language of the civil rule as follows:

     If the underlying facts or circumstances relied upon by
     a plaintiff may be a proper subject of relief, he ought
     to be afforded an opportunity to test his claim on the
     merits. In the absence of any apparent or declared
     reason--such as undue delay, bad faith or dilatory
     motive on the part of the movant, repeated failure to
     cure deficiencies by amendments previously allowed,
     undue prejudice to the opposing party by virtue of
     allowance of the amendment, futility of amendment,
     etc.--the leave sought should, as the rules require, be
     “freely given.” * * * [Foman v. Davis, 371 U.S. 178,
     182 (1962).]

     We conclude that the foregoing standard renders leave to

amend appropriate in the circumstances of the instant case.

Although the summary fashion in which the deduction issue was

initially presented by petitioners gave us insufficient

information to decide that the prejudice to respondent would not

outweigh that to petitioners, the parties through their various

motions, responses, and memoranda of law have now had the

opportunity to fully explain their positions.   While we continue

to look with disfavor upon petitioners’ initial failure to

appropriately plead the deduction issue, we are at this point

satisfied that the potentially prejudicial factual and procedural

concerns cited in our original opinion do not justify barring

petitioners from properly raising this issue through amendment.

When performed in light of the postopinion submissions, a
                               - 6 -

weighing of the relative potential for prejudice to petitioners

and to respondent convinces us that justice will be better served

by allowing leave to amend.

     First, before addressing more substantive matters, we make a

practical observation.   Petitioners allege that the estimated

cost to each of the four moving parties, if deductions for the

$1,292,699 paid apiece in Israeli income taxes are denied, will

be more than $1 million in additional U.S. tax, interest, and

penalties.   (The $1,292,699 figure derives from adding the

$296,554, $704,450, and $291,695 in taxes paid by each moving

party in 1991, 1992, and 1994, respectively.)    The economic

impact of our decision thus will not be insignificant.

     We now turn to the substance underlying the relief claimed

and its relationship to the record developed in this case.      As

explained in our earlier opinion, payment of taxes to a foreign

government may give rise to either a deduction or a credit.      See

secs. 164, 901.   Section 164(a)(3) provides that a deduction is

allowed for foreign income taxes.   In lieu of this deduction,

section 901(a) and (b)(1) permits a taxpayer to elect a credit

for foreign income taxes.

     Subject to limited exceptions not relevant here, the

deduction and credit provisions operate on a mutually exclusive

basis with respect to a particular tax year.    See sec.

275(a)(4)(A).   A taxpayer is precluded from deducting foreign
                                 - 7 -

taxes for a given year if he or she “chooses to take to any

extent the benefits of section 901”.       Id.   Nonetheless, under

section 901(a) and section 1.901-1(d), Income Tax Regs., an

election to claim either the deduction or the credit may be made

or changed at any time before the expiration of the special 10-

year period of limitations prescribed in section 6511(d)(3)(A).

Both parties in the present case apparently agree that an

election may be changed if such a claim is properly raised prior

to or in the course of litigation, but they differ as to whether

that was done here.

     Neither section 164 nor regulations promulgated thereunder

explicitly define the term “foreign income taxes”.       Case law,

however, does offer some guidance.       In general, U.S. legal

principles apply in determining the character of an alleged

foreign tax under section 164.    See Dubitzky v. Commissioner, 60

T.C. 29, 33 (1973).   With respect to section 901, regulations set

forth in detail the requirements for a tax to qualify as a

foreign income tax within the meaning of that section.       See sec.

1.901-2, Income Tax Regs.   Among other things, “A foreign levy is

an income tax if and only if--(i) It is a tax; and (ii) The

predominant character of that tax is that of an income tax in the

U.S. sense.”   Sec. 1.901-2(a)(1), Income Tax Regs.      Hence, for

either a deduction or a credit, the remittance must be in the
                                - 8 -

nature of a compulsory income tax under U.S. law.    The same

factual predicate thus applies under both provisions.

     Respondent’s notices of deficiency disallowing the credits

included statements similar to that in docket No. 19358-98:     “It

is further determined that since you have not established that

the foreign taxes were paid and/or incurred the credits are not

allowed in their entirety.”    Subsequently, the parties stipulated

that David Deitsch, Joseph Deitsch, Jacob Pinson, and Rachel

Sandman “made the following income tax payments to the State of

Israel during the taxable years 1991, 1992 and 1994”, and then

listed the corresponding dollar amounts under the heading

“Israeli Income Tax Paid”.    Petitioners apparently, and we

believe reasonably, viewed these stipulations as settling the

question of whether the payments were properly characterized as

foreign income taxes within the meaning of sections 164 and 901.

     At the trial which followed submission of the above

stipulations, neither party presented evidence relating to the

nature of the taxes paid.    The availability of the section 901

credit was litigated on the basis of whether the payments

petitioners received from their Israeli corporation were U.S. or

foreign source income.   Considerations of income source can

reduce or eliminate the amount that may be taken as a credit

under section 901, see sec. 904(a), but have no bearing on the

section 164(a)(3) deduction.    Nonetheless, on brief respondent
                               - 9 -

later contended as an alternative argument that petitioners had

failed to show that the Israeli tax payments satisfied the

creditability requirements of section 901 and the regulations

thereunder.   We did not reach this argument in our previous

opinion as it was mooted by our decision relating to the source

of petitioners’ income.

     Here then is the situation with which we are now faced.    A

plain reading of the parties’ stipulations would seem to indicate

that respondent did not reserve the right to question the nature

of the remittances to Israel when he stipulated that they were

“Israeli Income Tax Paid”.   Such, in turn, appears to have lulled

petitioners into assuming that respondent had conceded the

payments to be foreign income taxes as required for either a

credit or the alternative deduction.    Consequently, petitioners

further assumed, the factual predicate having been established,

that the deductions fell within the standard for items which may

be taken into account under Rule 155.

     Under Rule 155, the parties “submit computations pursuant to

the Court’s determination of the issues”.   Rule 155(a).   Thus the

Rule constitutes “the mechanism whereby the Court is enabled to

enter a decision for the dollar amounts of deficiencies and/or

overpayments” resulting from the Court’s substantive disposition.

Cloes v. Commissioner, 79 T.C. 933, 935 (1982).    A Rule 155

proceeding is an appropriate vehicle for dealing with “‘purely
                              - 10 -

mathematically generated computational items’.”     Harris v.

Commissioner, 99 T.C. 121, 124 (1992) (quoting Home Group, Inc.

v. Commissioner, 91 T.C. 265, 269 (1988), affd. 875 F.2d 377 (2d

Cir. 1989)), affd. 16 F.3d 75 (5th Cir. 1994).    It may not,

however, be used to raise “new issues”, Rule 155(c), which

generally has been construed in this context to mean matters

which would require consideration of evidence not already

contained in the record, see Harris v. Commissioner, supra at

124; Cloes v. Commissioner, supra at 935-937; Estate of Street v.

Commissioner, T.C. Memo. 1994-568.     Hence, while petitioners’

entitlement to section 164 deductions was in one sense an unpled

new matter, the underlying factual predicate, as petitioners

interpreted respondent’s stipulations, was not a new issue under

the standard enunciated for Rule 155.

     In this connection, we note that respondent had the

opportunity to present evidence at trial regarding the

characterization of the taxes, beyond the stipulations, and chose

not to do so.   Moreover, even now in extensive postopinion

submissions respondent has not alluded to any evidence which

might have been adduced to show the taxes were other than “income

taxes”, or to any further requirements for the deductions.

     Thus, while we acknowledge that respondent’s litigation

strategy may perhaps have been affected by petitioners’ failure

expressly to raise the deduction issue prior to trial, we believe
                              - 11 -

that the circumstances of this case reveal an even greater

potential for prejudice to petitioners.   To recapitulate, we

focus particularly on the similarity of the underlying

substantive requirements for a credit versus a deduction,

respondent’s apparently unreserved stipulations and opportunity

to adduce evidence to the contrary, and petitioners’ reliance on

the standard set forth in case law for Rule 155 consideration.

In this context, concerns of justice counsel us not summarily to

refuse petitioners the opportunity under Rule 41(a) to plead this

issue and thereby to render it at least a possible subject of a

Rule 155 computation.   We thus will grant petitioners’ motions to

amend.

     Furthermore, now that such amendment brings this issue

properly before the Court, we shall reconsider that portion of

our prior opinion which declined, on the grounds that the matter

had been raised solely on brief, to permit petitioners to reserve

the right to deduct foreign taxes as part of a Rule 155

computation.   We therefore will grant petitioners’ motion for

reconsideration to the limited extent of the supplemental

findings of fact and conclusions below.

     In our memorandum opinion, we found the following:

          Commencing in 1987, FIL also began making payments
     by wire transfer directly to accounts in the name of
     “Flocktex shareholders”. For the years at issue, the
     recipients and amounts of these payments are set forth
     below:
                                 - 12 -


                   1991            1992         1993           1994
David Deitsch     $875,000      $2,350,000       -0-        $1,000,000

Mordecai            -0-             -0-          -0-            -0-
Deitsch

Joseph Deitsch     875,000       2,350,000       -0-         1,000,000

Rachel Sandman     875,000       2,350,000       -0-         1,000,000

B. Mayer Zeiler     -0-             -0-          -0-            -0-

Jacob Pinson       875,000       2,350,000       -0-         1,000,000


     Through withholding, income taxes were paid by the
     recipients to the State of Israel on the amounts shown
     above. Letters issued by Israeli authorities
     certifying receipt of the income taxes specify that the
     sums were due in respect of “commission fees” from FIL.

     Additionally, as noted above, the parties stipulated,

without any reservations, the respective amounts of “Israeli

Income Tax Paid” by the movants.       These stipulations, which we

now incorporate as explicit findings of fact, read:

          Petitioner David Deitsch made the following income
     tax payments to the State of Israel during the taxable
     years 1991, 1992 and 1994:

           Year              Flocktex Payment    Israeli Income Tax Paid

           1991                  $875,000              $296,554
           1992                 1,100,000               322,273
           1992                 1,250,000               382,177
           1994                 1,000,000               291,695


          Petitioner Joseph Deitsch made the following
     income tax payments to the State of Israel during the
     taxable years 1991, 1992 and 1994:

           Year              Flocktex Payment    Israeli Income Tax Paid

           1991                  $875,000              $296,554
                             - 13 -

        1992                1,100,000               322,273
        1992                1,250,000               382,177
        1994                1,000,000               291,695


          Petitioner Jacob Pinson made the following income
     tax payments to the State of Israel during the taxable
     years 1991, 1992 and 1994:

         Year            Flocktex Payment   Israeli Income Tax Paid

        1991                 $875,000              $296,554
        1992                1,100,000               322,273
        1992                1,250,000               382,177
        1994                1,000,000               291,695


          Petitioner Rachel Sandman made the following
     income tax payments to the State of Israel during the
     taxable years 1991, 1992 and 1994:

         Year            Flocktex Payment   Israeli Income Tax Paid

        1991                 $875,000              $296,554
        1992                1,100,000               322,273
        1992                1,250,000               382,177
        1994                1,000,000               291,695

     Based on the foregoing stipulations, we hold that

petitioners’ respective payments of Israeli income taxes are

deemed to satisfy the creditability requirements of section 901

and the regulations thereunder and to constitute foreign income

taxes within the meaning of section 164(a)(3).   Consequently, a

deduction for these remittances may be included in the parties’

Rule 155 computations.
                               - 14 -

II.   Respondent’s Motion for Reconsideration

      Having disposed of petitioners’ motions, we next turn our

attention to respondent’s motion for reconsideration.   In our

memorandum opinion, we considered the characterization, and

corresponding tax treatment, of two types of payments received by

petitioners from FIL:   (1) Payments made directly to certain of

petitioners (termed “special commissions”), and (2) payments made

to a partnership and reported by certain of petitioners as their

distributive shares of partnership income.   We refused to accept

petitioners’ argument that these amounts were in substance

dividends and should be treated as such for tax purposes.    In so

doing, we highlighted a number of representations contained in

the record which convinced us that both types of payments must be

treated as compensation.   Included amongst those representations

was petitioners’ designation of the payments on their Forms 1116

as “General limitation income”.   We further cited the general

rule that compensation would be identified for purposes of this

form as “General limitation income” while dividends would

typically be placed in the “Passive income” category.

      Against this background, respondent states on motion that

petitioners’ Form 1116 reporting is consistent with our holding

that the payments are properly characterized as consulting or

compensation income.    However, respondent asks us to clarify that

petitioners’ classifying of the payments from FIL as general
                              - 15 -

limitation income is not in and of itself inconsistent with the

payments’ being in the nature of dividends, suggesting that such

clarification “would prevent any misunderstanding of the relevant

authorities by the general public.”

     Respondent points out that FIL appears to be a controlled

foreign corporation (CFC), as defined in section 957, and

therefore would be subject to the “look-thru” rules of section

904(d)(3).   Pursuant to that section, dividends received by U.S.

shareholders of a CFC would typically be characterized pro rata

in accordance with the nature of the various types (if more than

one) of the underlying income of the CFC.   See sec. 904(d)(3)(D);

see also sec. 1.904-5(c)(4), Income Tax Regs.   Hence, dividends

from a CFC may in many cases properly be categorized as general

limitation income rather than as passive income.

     Petitioners join in respondent’s motion and further urge the

Court to reconsider and hold (1) that petitioners are not

precluded from arguing substance over form with respect to the

special commissions, and (2) that petitioners have met their

burden of showing the payments to be dividends in substance.

(Petitioners do not dispute for purposes of this motion that the

payments made to the partnership were taxable as compensation for

services.)   Petitioners argue that in light of the now-conceded

consistency of their Form 1116 reporting with their foreign

source dividends assertion, the “fact that the return preparer
                              - 16 -

reported the payments on the wrong line of the returns and, in

some cases, misdescribed them on schedules attached to returns”

should not estop petitioners from prevailing on this point.

     Although FIL’s status as a CFC was not previously raised or

relied upon by either party, we believe that the clarification

advocated by respondent is warranted to prevent any confusion.

We shall grant respondent’s motion and supplement our memorandum

opinion to the extent of the above explanation regarding the

treatment of dividends received from a CFC.   However, we decline

petitioners’ invitation to alter our original holding that the

special commission payments must be treated as U.S. source

compensation income.

     Contrary to petitioners’ averments, we are satisfied that,

regardless of the interpretation to be placed on petitioners’

Form 1116 reporting, the standards governing substance over form

arguments continue to support the result reached in our previous

opinion.   At best, we are still faced with a record fraught by

ambiguity and inconsistencies.   Moreover, not a single document

contained therein makes any affirmative or explicit

representation that the payments were in the nature of dividends.

To the contrary, and we summarize only briefly here, petitioners’

Forms 1040, U.S. Individual Income Tax Returns, and Schedules B,

Interest and Dividend Income, do not show the special commissions

as dividends.   FIL’s financial records designate the payments as
                              - 17 -

selling expenses.   Letters from the Israeli administration state

that “Flocktex did not pay dividends to shareholders * * * but

instead paid a special commission.”

     We further observe that petitioners raised in their post-

trial briefing the alternative contention that even if the

payments from FIL were considered compensation, they were

nonetheless foreign source income.     Since identifying the amounts

as general limitation income would appear to be equally

consistent with this scenario, we find the Forms 1116 reveal

little about the transactions at issue.    A Form 1116

categorization potentially supportive of multiple

characterizations does not outweigh the balance of the record.

     Hence, whatever can be inferred from petitioners’ Forms

1116, we simply see no honest and consistent respect for the

alleged substance in either reporting or other representations

and actions that would justify a result different from that

reached in our memorandum opinion.

     To reflect the foregoing,

                                      Appropriate orders will be

                                 issued granting petitioners’

                                 motions to amend, petitioners’

                                 motion for reconsideration, and

                                 respondent’s motion for

                                 reconsideration.
