                    118 T.C. No. 13



                UNITED STATES TAX COURT



ELECTRONIC ARTS, INC. AND SUBSIDIARIES, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

   ELECTRONIC ARTS PUERTO RICO, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 2433-99, 2434-99.      Filed March 22, 2002.



     Before the years in issue, petitioner parent (EA)
had relied on unrelated video games manufacturers in
Taiwan and Japan to manufacture the video games that EA
sold. EA created a subsidiary (EAPR) to move the video
game manufacturing operations to Puerto Rico. EAPR
entered into agreements with an unrelated company
(PPI), which was located in Puerto Rico. PPI
manufactured ignition modules and related products for
small engines. PPI did not own equipment, raw
materials, or components to manufacture video games.
Under the EAPR-PPI agreements, EAPR leased space in
PPI’s factory, leased employees from PPI, bought
capital equipment which was installed in the leased
space, bought components and raw materials, and
provided the foregoing to PPI in order to manufacture
video games. PPI was paid for its services. EAPR sold
the resulting video games to EA. The video games in
                              - 2 -

     dispute that EA bought from EAPR were manufactured in
     Puerto Rico.

          Petitioners moved for partial summary judgment,
     contending that (1) EAPR is entitled to possessions tax
     credits because it met the “active conduct of a trade
     or business” in Puerto Rico requirement of sec.
     936(a)(2)(B), I.R.C. 1986, and (2) in determining the
     amount of these credits, EAPR is entitled to compute
     its income under the profit split method (sec.
     936(h)(5)(C)(ii), I.R.C. 1986) because it maintained a
     “significant business presence” in Puerto Rico within
     the meaning of sec. 936(h)(5)(B)(ii), I.R.C. 1986.

          1. Held: Ps are entitled to partial summary
     judgment that EAPR met the “active conduct of a trade
     or business” in Puerto Rico requirement of sec.
     936(a)(2)(B), I.R.C. 1986. MedChem (P.R.), Inc. v.
     Commissioner, 116 T.C. 308 (2001), on appeal (1st Cir.,
     Aug. 24, 2001), followed as to the law and
     distinguished on the facts.

          2. Held, further, Ps are entitled to partial
     summary judgment that EAPR maintained a “significant
     business presence” in Puerto Rico within the meaning of
     sec. 936(h)(5)(B)(ii), I.R.C. 1986, without regard to
     the requirements of the final flush language of that
     provision.

          3. Held, further, Ps have failed to show that they
     are entitled to partial summary judgment that EAPR
     maintained a “significant business presence” in Puerto
     Rico within the meaning of sec. 936(h)(5)(B)(ii),
     I.R.C. 1986, taking into account the requirements of
     the final flush language of that provision. That is,
     Ps have failed to show that the video games were
     “manufactured * * *in * * * [Puerto Rico] by * * *
     [EAPR] within the meaning of subsection (d)(1)(A) of
     section 954”, I.R.C. 1986.



     A. Duane Webber and Andrew P. Crousore, for petitioners.

     Michael R. Cooper, William R. Davis, Jr., Gregory M. Hahn,

and Virginia L. Hamilton, for respondent.
                                 - 3 -

                                OPINION

     CHABOT, Judge:   The instant cases are before us on

petitioners’ motion under Rule 1211 for partial summary judgment

that petitioner Electronic Arts Puerto Rico, Inc. (hereinafter

sometimes referred to as EAPR), is entitled to possessions tax

credits under section 9362 for the years in issue computed using

the “profit split method”.

     Respondent determined deficiencies in corporate income tax

against petitioner Electronic Arts, Inc. and Subsidiaries

(hereinafter sometimes referred to as EA) and against petitioner

EAPR, as follows:

     Fiscal Year1                EA           EAPR

         1993                 $121,795     $1,977,045
         1994                1,239,846      2,959,550
         1995                7,000,775      2,646,755
1
   Taxable years ending March 31 of each of the years in issue.
References in this opinion to either petitioner’s fiscal years
are to that petitioner’s taxable year ending March 31 of the
indicated years. Fiscal 1996 is involved as to EA because of a
net operating loss carryback from fiscal 1996 to fiscal 1993.

     Petitioners claim overpayments as follows:




     1
      Unless indicated otherwise, all Rule references are to the
Tax Court Rules of Practice and Procedure.
     2
      Unless indicated otherwise, all section references are to
sections of the Code as in effect for the years in issue, and all
Code references are to the Internal Revenue Code of 1986.
                                - 4 -

      Fiscal Year               EA1              EAPR

          1993                $65,000         $4,519
          1994                 65,000          7,739
          1995              1,450,000            --
1
    EA claims these amounts as minimum overpayment amounts.

      The issues for decision under petitioners’ motion for

partial summary judgment are as follows:

           (1)   Whether EAPR was engaged in the active

      conduct of a trade or business in Puerto Rico during

      the years in issue and was entitled to section 936

      possessions tax credits for these years.    (This issue

      affects both dockets.)

           (2)   If yes, then whether EAPR had a significant

      business presence in Puerto Rico, with respect to the

      manufacture3 of standardized video game cartridges

      (hereinafter sometimes referred to as video games),

      during the years in issue so as to entitle EAPR to

      elect to use the profit split method in lieu of the

      general rule of section 936(h)(1).   Subsidiary

      questions are (a) whether the video games were



      3
      The statute uses the phrase “manufactured or produced”.
The parties’ stipulations in 12 instances refer to the video
games as having been “manufactured” and in 2 instances as having
been “produced”. It is not clear what is the congressionally
intended difference between “manufactured” and “produced”. The
Court does not discern any difference that would have
consequences for the instant cases, and, so far as we can tell
neither do the parties.
                                 - 5 -

     manufactured in Puerto Rico, and (b) whether EAPR’s

     activities constituted the manufacture of the video

     games in Puerto Rico by EAPR “within the meaning of

     subsection (d)(1)(A) of section 954”, as required by

     section 936(h)(5)(B)(ii) (final flush).     (This issue

     affects only the EAPR docket, 2434-99.)

     Our statements as to the facts are based entirely on the

parties’ stipulations of facts and exhibits, those matters that

are admitted in the pleadings, those matters that are admitted in

the motion papers, and those matters set forth in affidavits

submitted by the parties.

                            I.   Background

A.   The Petitioners

     When the respective petitions were filed in the instant

cases, both EA and EAPR were Delaware corporations with their

principal corporate offices in Redwood City, California.       (EA was

incorporated in Delaware in September 1991; its predecessor was

incorporated in California in 1982.)     For the years in issue,

both EA and EAPR kept their books and filed their income tax

returns on the basis of an accrual method of accounting and a

fiscal year ending March 31.

     During the years in issue, EA developed, manufactured (or

had manufactured), marketed, and distributed interactive

entertainment software for a variety of entertainment systems,
                                - 6 -

including such well-known entertainment systems as the Sega

Genesis, Sony Playstations, and Nintendo Systems, as well as

Apple and IBM-compatible computers.     EA derived its revenues

during the years in issue predominantly from the sale to both

U.S. and foreign customers of standardized video game cartridges

and compact discs containing entertainment software.     Under a

license agreement between EA and Sega Enterprises Ltd.

(hereinafter sometimes referred to as Sega), dated July 1992,

Sega granted to EA and any affiliate controlled by EA a license

to use Sega intangible property to develop, manufacture, market,

and sell video game cartridges compatible with the Sega Genesis

systems.   EA distributed products primarily through its own sales

force in the United States, which sold directly to retail chains

and outlets.    Outside the United States, EA distributed its

products primarily through affiliates and third-party

distributors.

     Before the years in issue, EA relied on unrelated video game

manufacturers located in Taiwan and Japan to manufacture the

video games.

     Beginning in 1991 (during EA’s fiscal 1992), EA became

interested in, and investigated the feasibility of, establishing

a video game undertaking in Puerto Rico through a wholly owned

subsidiary.    In 1992, EA engaged Richard Baker as a consultant to

provide advice in connection with the investigation and
                               - 7 -

establishment of such an undertaking.   EAPR was incorporated

under Delaware law on May 15, 1992, as a subsidiary of EA, to

manufacture video games and other software entertainment

products.   EA bought video games from EAPR in each of the years

in issue.

B.   Agreements; Procedures

     EA issued purchase orders to EAPR for video games.    EA

generated these purchase orders in San Mateo, California.     When

EAPR, through its manager and employees covered by the

Manufacturing Services Agreement (hereinafter sometimes referred

to as the Agreement), shipped completed video games to EA, EAPR’s

manager or an employee covered by the Agreement (hereinafter

sometimes referred to as a lease employee) input into EAPR’s

computerized Material Requirement Planning System (hereinafter

sometimes referred to as the MRP System) shipping data relating

to the shipment.   (The Agreement, including the arrangements as

to lease employees, is described in greater detail infra I.E.)

The MRP System was used to manage EAPR’s inventories by tracing

(a) raw materials and components as inputs and inventory, (b)

production schedules, (c) movements of material and component

inventories through stages of the manufacturing process, and (d)

finished video games as outputs relating to the manufacture of

video games in Puerto Rico.   An invoice from EAPR then was

generated in San Mateo with respect to the completed video games.
                               - 8 -

EA, through its accounting department, paid EAPR’s invoices by

making wire transfers from EA’s bank account to EAPR’s bank

account in Puerto Rico during the years in issue. After EAPR was

established, substantially all the video games that EA bought for

Sega Genesis systems were manufactured in Puerto Rico.   By the

end of 1993, EA stopped buying video games for Sega Genesis

systems from unrelated parties in Asia.   The video games in

dispute that EA bought were manufactured in Puerto Rico.

     EAPR as lessee entered into a commercial lease (hereinafter

sometimes referred to as the Lease) with Power Parts, Inc.

(hereinafter sometimes referred to as PPI), on June 25, 1992,

relating to a portion of the facilities PPI owned in Santa

Isabel, Puerto Rico.   Through 1993, the Lease applied to an area

of 4,500 square feet, which by oral agreement was increased to

6,000 square feet in 1994, and 8,000 square feet in 1995 and

later years.   The leased space was segregated from PPI’s

manufacturing operations.   The leased space was a room in a

different part of PPI’s building and was protected by EAPR’s

security system, which included video camera surveillance and a

combination lock door entrance.   Access to the leased space was

allowed only to EAPR’s manager, EAPR’s CFO, lease employees, and

PPI employees who performed services covered by the Agreement.

The leased space was used exclusively for the manufacture of

video games and for related functions.
                                - 9 -

     The Agreement required EAPR to provide, “at its own cost and

expense,” all the capital equipment needed to manufacture the

video games, and required this equipment to be located in the

leased space.    Under the Agreement, PPI was responsible for

routine normal maintenance and EAPR was responsible for repairs,

parts, and replacement.    EAPR bought, and during the years in

issue owned, all of the equipment (including wave solder

machines, production assembly lines, label machines, and test

equipment) used in Puerto Rico to manufacture the video games.

EAPR bought the equipment from unrelated sellers.

     The Agreement required EAPR to provide “all materials and

components for the manufacture of Products [the video games].”

The Agreement provided that EAPR was responsible for ordering

these items and paying for them, and “PPI shall have no authority

to order or purchase or otherwise represent EAPR with respect to

such materials and components.”    The manufacture of video games

required various components and materials, including ROM and RAM

chips, printed circuit boards, batteries, plastic cases, and

other parts.    EAPR paid for and owned all such components and

materials used in Puerto Rico to manufacture the video games in

issue.   Raw materials and components were obtained from unrelated

suppliers.   EA’s personnel in San Mateo issued purchase orders to

vendors for raw materials and components on behalf of EAPR.
                              - 10 -

     EAPR maintained its own bank account in Puerto Rico from

which it paid for raw materials and components, labor (including

amounts paid to PPI), and other supplies and services.   EAPR’s

board of directors authorized officers of EAPR and two employees

of EA’s accounting department to execute checks on behalf of

EAPR.   EAPR’s checks for raw materials and components, labor

(including amounts paid to PPI), and other supplies and services

were prepared and signed on EAPR’s behalf by these authorized

people in EA’s offices in San Mateo.

     EA employees in San Mateo entered purchase forecast and

order information into the MRP System.   Unrelated vendors shipped

raw materials and components directly to EAPR in Puerto Rico,

based on need as determined under the MRP System.   Deliveries of

raw materials and components were received and inspected by

EAPR’s manager, lease employees, or PPI employees; these services

by PPI employees were covered by the Agreement.   The raw

materials and components were stored in separately identified

warehouse space covered by the Lease.

     At or near the end of each fiscal year, one or more lease

employees, under the supervision of EAPR’s manager and an

accounting staff person from EA who visited Puerto Rico for this

purpose, performed a physical inventory of EAPR’s materials

inventory, work in process, and finished goods.
                               - 11 -

     At all times during the manufacture of the video games in

Puerto Rico, EAPR owned all materials and components, work in

process inventory, and finished products relating to the video

games that EA bought.

     EA bought from EAPR the video games in dispute in the

instant cases.    EAPR was not a sham corporation.

C.   Manufacturing Process

     Video games were manufactured in the leased space covered by

the Lease, that is, the leased portion of the facilities owned by

PPI in Santa Isabel.    The following general steps were used in

manufacturing these video games:    The raw materials and

components necessary for a production run were procured from the

warehouse space covered by the Lease and placed in the production

area as needed.    The leads on various components for each video

game (including capacitors, resistors, and integrated circuits)

were formed (i.e., bent and cut, as required) using various types

of formers.   The formed components were then supplied to a “push-

along” assembly line in which they were inserted, along with ROM

chips and any batteries or other required components, into bare

printed circuit boards.

     The circuit boards with the inserted items4 were then placed

on the automatic conveyer in a wave solder machine, where flux



     4
      We assume that that is what the parties mean by their
stipulated--but undefined--term “populated boards”.
                              - 12 -

was deposited on the soldering points (i.e., the contact points

between the components and the printed circuit board) and the

boards were conveyed through a bath of liquid solder that

soldered the components to the board at these points.    The

soldered boards were then inspected, any defective solder joints

were resoldered by hand (if possible), and any other defects were

reworked or repaired.

     The boards were then cleaned and repaired to remove any

excess solder and debris, and were transferred to the testing

area where the boards were tested for electronic functionality.

The tested boards were then assembled into video game cartridge

housings, together with any other necessary components and the

appropriate labels.   The finished video games were then fully

tested again for the overall functionality of the game; the

tested games were then boxed and prepared for shipping and were

subject to a further quality audit before transfer from the

leased production area covered by the Lease to the warehouse

space covered by the Lease.

     The lease employees performed the above-described

manufacturing processes.
                                 - 13 -

     Table 1 shows the number of video game cartridges that were

manufactured in Puerto Rico that EAPR sold and delivered to EA

during the years in issue.5

                                 Table 1

                    Fiscal Year               Units

                          1993               2,588,306
                          1994               7,378,471
                          1995               6,485,815
                          1996               4,077,218

D.   PPI

     PPI was a Delaware corporation based in Santa Isabel; it was

an affiliate of R.E. Phelon Company, Inc., a U.S. corporation.

PPI was not related to EA or EAPR.        In its Santa Isabel facility,

PPI manufactured proprietary ignition modules and related

products for use in small engines.        PPI had about 300 employees

in Santa Isabel in connection with this business.        PPI did not

own the equipment, raw materials, and components necessary to

manufacture video games.

E.   EAPR-PPI Agreement

     On June 25, 1992, EAPR and PPI entered into the Agreement,

relating to the lease employees and certain services.        Under the

Agreement, EAPR was required to give to PPI (and update



     5
      It is not always obvious when the parties’ stipulations are
intended to refer to fiscal years and when to calendar years. In
this instance, we believe the parties intended their stipulation
to refer to fiscal years, even though the stipulation does not
say so.
                              - 14 -

quarterly) a forecast of the number of “employees expected to be

required by EAPR for each production or other operation and on

each shift for each calendar month”.   PPI was required to “use

its best efforts to dedicate and lease to EAPR the number of

employees shown in each then current Manpower Forecast subject to

the availability of such employees.”

     Under the Agreement, PPI was required to hold EAPR harmless

from any liability resulting from any third-party claim against

EAPR to the extent the liability “(iv) relates to PPI’s

employment of any employee leased to EAPR hereunder but does not

relate to EAPR’s supervision of such employee.”   EAPR was

required to hold PPI harmless from any liability resulting from

any third-party claim against PPI to the extent the liability

“(vii) relates to EAPR’s supervision of any employee leased by it

from PPI hereunder”.

     Under the Agreement, EAPR was required to compensate PPI for

the lease employees’ hourly wages burdened for overhead expenses,

plus a 30-percent markup.   EAPR was required to pay an additional

10 percent of the employee lease charge for other services,

including receiving goods, shipping, incoming and outgoing

inspections, security, and utilities and maintenance.   In return,

PPI was responsible for payroll, worker’s compensation, and

related taxes attributable to the wages of the lease employees.

Under the Agreement, EAPR made advance payments to PPI on a per-
                              - 15 -

video game basis with respect to the fees for the lease employees

and other services.

     Under the Agreement, which sets forth a nonexclusive list of

10 “Services”, PPI agreed to provide “Day to day management of

employees leased by EAPR pursuant to Section 2 [of the

Agreement].”   Section 2 of the Agreement, entitled “Lease of

Employees”, provides in pertinent part as follows:

     All employees leased by PPI hereunder shall be located
     in the Premises leased by EAPR from PPI and shall be
     under the general supervision of EAPR. EAPR shall also
     supervise and control all technical and product-related
     training required by such employees. EAPR shall have
     the right to locate its own employees in the building
     space leased by it from PPI for the purpose of
     overseeing and directing the work of the employees
     leased to it by PPI subject to the requirements of the
     Lease attached hereto as Exhibit A. [The Lease is not
     attached to the stipulated copy of the Agreement, but
     the Lease is in the record in the instant cases as a
     separately stipulated exhibit.]

     The Lease provides in pertinent part as follows:

          3. USE: The Premises are to be used as a
     manufacturing facility for the manufacture of videogame
     cartridges and shall be used solely by those employees
     leased from Lessor [PPI] by Lessee [EAPR] pursuant to a
     manufacturing services agreement and by one additional
     employee of Lessee, unless Lessor consents to use by
     other employees, and for no other purpose, without the
     prior written consent of Lessor.

     PPI invoiced EAPR for all labor costs as specified under the

Agreement on the basis of the number of completed video games.

This invoice charge included the amount of any taxes and

unemployment contributions paid with respect to lease employees.

The amount invoiced was determined based on labor costs, taxes,
                                 - 16 -

unemployment contributions, overhead, and a profit for PPI.      EAPR

paid PPI’s invoices with respect to the lease employees and

services covered by the Agreement.

     The lease employees performed manufacturing functions

relating to video games.   During 1993 through 1996 the

manufacture of the video games that EAPR delivered to EA required

about 35 regular full-time employees during normal production

periods.   During peak production periods up to about 400 or more

additional lease employees in multiple shifts were necessary to

meet EAPR’s production schedule.

F.   EAPR’s Manager and Officers

      EAPR employed a manager who at all times during the years in

issue lived in Puerto Rico and worked in the leased space.

During fiscal 1993 through fiscal 1996 (supra note 5) the

following people held the position of manager:      Willie Zamora,

Jose Cruz, and Orlando Alvarado, hereinafter sometimes referred

to as Zamora, Cruz, and Alvarado, respectively.      Table 2 shows

the total salaries and fringe benefits EAPR paid to its manager

during these years.

                              Table 2

                   Fiscal Year            Amount

                       1993               $43,940
                       1994                61,729
                       1995                38,262
                       1996                46,035
                               - 17 -

     Zamora died in August 1993.    Cruz was hired as Zamora’s

assistant 2 weeks before Zamora died.    Cruz’s employment was

terminated after 3-1/2 weeks--1-1/2 weeks after Zamora died.      In

December 1993, Alvarado was hired as EAPR’s manager.    During the

5 or so months after Zamora died and before Alvarado was hired, a

number of EA’s employees came to Puerto Rico on 2-week details to

do the necessary work.6   Once hired, Alvarado served as EAPR’s

manager until the summer of 1996.

     As EAPR’s manager, Alvarado supervised two or three PPI

employees in charge of managing materials, from raw materials

through work in process to finished goods.    Alvarado supervised

PPI employees who worked on inventory control and saw to it that

they entered the correct data into the computer for operation of

the MRP systems.   In general, Alvarado did not deal directly with

the assembly line operation.   However, if he saw mistakes being

made, then he saw to it that the mistakes were corrected.    Also,

PPI called him in for assistance “If things were going wrong”.


     6
      Much of the material in this item F. EAPR’s Manager and
Officers, is based on statements in unsigned declarations by Cruz
and Alvarado, attached to an affidavit submitted by respondent.
Petitioners’ counsel agreed that they would not raise hearsay
objections to these declarations. On brief, petitioners contend
that documents from personnel files which petitioners provided to
respondent would “definitely establish” that Zamora died on Oct.
16, 1993 (not in August 1993), and that Cruz was hired after Oct.
16, 1993 (not 2 weeks before Zamora died). No such personnel
file documents are before us. In any event, the essential thrust
of our conclusions would not be affected by the modifications
that might be required by the above-described personnel file
documents.
                               - 18 -

     Various EA corporate officers served as directors or

corporate officers of EAPR.   As with various officers and

directors of other EA affiliates, they were not separately

compensated for serving as officers of EAPR.      The compensation

paid to EA’s officers (including those who were officers of EAPR)

was included in EA’s general administrative expense.      EA’s

general administrative expense was included in the computation of

the combined profit for purposes of applying the profit split

computation under section 936(h).

G.   EAPR’s Finances

      EAPR’s cost of goods sold with respect to video games

included direct costs and period costs.      Direct costs included

materials and labor.   Labor costs included amounts paid to PPI

pursuant to the Agreement.    Period costs included materials and

labor for “rework” (a stipulated, but undefined, term).

      Table 3 shows EAPR’s total cost of goods sold relating to

the video games it sold to EA, and net sales of video games to EA

(without regard to the profit split allocation under section

936(h)(5)).

                               Table 3

      Fiscal Year         Cost of Goods Sold           Net Sales

         1993                  $21,119,356            $22,488,000
         1994                   56,807,000             59,211,000
         1995                   76,429,990             79,559,000
         1996                   42,500,108             45,004,000
                               - 19 -

                          II. Discussion

                          A.   In General

      Summary judgment is a device used to expedite litigation; it

is intended to avoid unnecessary and expensive trials.   However,

it is not a substitute for trial; it should not be used to

resolve genuine disputes over material factual issues.     Cox v.

American Fidelity & Casualty Co., 249 F.2d 616, 618 (9th Cir.

l957); Vallone v. Commissioner, 88 T.C. 794, 801 (1987).     A

decision will be rendered on a motion for partial summary

judgment if the pleadings, answers to interrogatories,

depositions, admissions, and other acceptable materials, together

with the affidavits, if any, show that there is not any genuine

issue as to any material fact and that a decision may be rendered

as a matter of law.   Rule 121(b).   A partial summary adjudication

may be made which does not dispose of all the issues in the case.

Id.

      Because the effect of granting a motion for summary judgment

is to decide the case against a party without allowing that party

an opportunity for a trial, the motion should be “cautiously

invoked” and granted only after a careful consideration of the

case.   Associated Press v. United States, 326 U.S. 1, 6 (1945);

Cox v. American Fidelity & Casualty Co., 249 F.2d at 618; Kroh v.

Commissioner, 98 T.C. 383, 390 (1992).
                              - 20 -

     Petitioners, as the moving parties, have the burden of

showing the absence of a genuine issue as to any material fact.

For these purposes, the party opposing the motion is to be

afforded the benefit of all reasonable doubt, and the material

submitted by both sides must be viewed in the light most

favorable to the opposing party; that is, all doubts as to the

existence of an issue of material fact must be resolved against

the movants.   E.g., Adickes v. Kress & Co., 398 U.S. 144, 157

(1970); Dreher v. Sielaff, 636 F.2d 1141, 1143 n.4 (7th Cir.

1980); Kroh v. Commissioner, 98 T.C. at 390.

     In the instant cases, respondent has not filed any cross-

motion for partial summary judgment.   Where, as in the instant

cases, only one side has moved for summary judgment, there is

implicit in the movants’ obligations as to material facts that

the movants have to persuade the Court that they have correctly

identified what facts are material.

     Petitioners submitted the affidavits of Richard C. Baker and

J. Everett Milott.   Richard C. Baker, a consultant in the early

1990s, describes his role in the establishment of EAPR, the

establishment of the operations in the facility that EAPR leased

from PPI, and the activities of Zamora.   J. Everett Milott, PPI’s

executive vice present and general manager when he executed his

affidavit, describes PPI‘s activities from 1992 through 1996 in

connection with the Agreement and the Lease.   Respondent
                              - 21 -

submitted the affidavits of Michael J. Cooper and Dale L. Curren,

and the declaration of Patricia Zentner.   Michael J. Cooper

describes the events leading to the unsigned declarations of Cruz

and Alvarado (supra note 6 and accompanying text).   Dale L.

Curren, a computer systems analyst with respondent’s Office of

Chief Counsel, describes and furnishes a PPI homepage and PPI

contact page secured at some unstated date, which appears to have

been no earlier than August 4, 1999.   Patricia Zentner, an

international examiner for respondent, describes various

documents she sent to, or received from EA (and her notes on

those documents), and various documents showing that certain

paperwork in connection with EAPR activities originated in EA’s

offices in San Mateo, California.   For purposes of the instant

partial summary judgment motion, we have treated the statements

as to matters of fact in the Alvarado declaration as though (1)

they accurately describe the events they deal with, and (2) the

events that occurred before Alvarado was hired also were

consistent with these statements--except, of course, to the

extent that the statements are contrary to the parties’

stipulations.

     One more preliminary matter:   At various points in their

analyses, both sides urge us to follow the “plain meaning” of the

statutes.   Of course, each side understands the plain meaning to

be about 180 degrees different from the other side’s view of the
                               - 22 -

plain meaning.    Our reaction is that none of the issues that the

parties have asked us to rule on in the partial summary judgment

motion before us can be resolved by merely looking at the plain

meaning of the statutes we deal with.

     We consider first (both dockets) whether petitioners are

entitled to partial summary judgment that EAPR was engaged in the

active conduct of a trade or business in Puerto Rico so as to

entitle it to possessions tax credits for the years in issue.    We

then consider (the EAPR docket) whether petitioners are entitled

to partial summary judgment that EAPR had a significant business

presence in Puerto Rico so as to entitle it to compute its

taxable income using the “profit split” method for the years in

issue.

             B.   Active Conduct of a Trade or Business

1.   Parties’ Contentions

     Respondent contends that petitioners’ partial summary

judgment motion must be denied because (1) “as a matter of law

* * * Petitioners cannot attribute the activities of the PPI or

EA employees to EAPR” to satisfy the active-conduct-of-a-trade-

or-business test under section 936(a)(2)(B); and (2) if

attribution is not per se impermissible, then “there are material

facts in dispute that are relevant to the statutory” test.

     Petitioners contend that the tax credit under section 936,

and the predecessor statutes back to 1921 (which provided an
                              - 23 -

income tax exemption instead of a credit), “were enacted to

stimulate the creation of jobs and investment in U.S.

possessions, and to provide a tax benefit to taxpayers that

created such jobs and investment.”     They urge us to “construe

section 936 in favor of [such] taxpayers” and to “construe

narrowly any limitations on the intended benefits”.     Petitioners

further contend that the functions performed by the lease

employees “are properly considered, as a matter of law, to be

functions performed by EAPR in Puerto Rico for purposes of

applying the active trade or business test.”     Finally,

petitioners contend that “There are no facts upon which

Petitioners rely that are reasonably in dispute.”     Petitioners

further maintain that, even if we were to agree with respondent’s

contentions that certain factual matters are in dispute, these

matters “are not material to a holding by the Court on this issue

[i.e., that EAPR derived income from the active conduct of a

trade or business in Puerto Rico].”

2.   Summary of Conclusions

      We agree with several of petitioners’ contentions and with

petitioners’ conclusion that their motion for partial summary

judgment on the active-conduct-of-a-trade-or-business issue

should be granted.

      The Code does not appear to include a definition of the term

“active conduct of a trade or business” as that term is used in
                              - 24 -

section 936(a)(1)(A)(i).   That term is used in more than 20 other

sections of the Code, and we do not find a statutory definition

for that term as used in any of these other sections.     Code

provisions generally are to be interpreted so congressional use

of the same words indicates an intent to have the same meaning

apply, and congressional use of different words indicates an

intent to have a different meaning apply.   Under these

circumstances, authoritative interpretations of that term as used

in other provisions of the Code may be regarded as proper

precedent for interpreting that term as used in section 936(a).

In particular, we focus on opinions interpreting that term in the

Western Hemisphere Trading Corporations context, and on Treasury

Regulations interpreting that term in the context of sections

179, 355, and 367.   Applying our analysis in MedChem (P.R.), Inc.

v. Commissioner, 116 T.C. 308 (2001), on appeal (1st Cir., Aug.

24, 2001), and the interpretations in Western Hemisphere Trading

Corporations cases to the factual matters established by the

parties’ stipulations, pleadings, affidavits, etc., we conclude

that EAPR’s activities amounted to the active conduct of a trade

or business in Puerto Rico, within the meaning of section 936(a),

during the years in issue.

     We conclude that respondent’s contentions as to disputes

over factual matters are all (1) contradicted by the stipulations

or pleadings, or (2) immaterial, or (3) both.
                             - 25 -

     We hold, for petitioners, that they are entitled to the

partial summary judgment they seek on this issue.

3. Analysis

     Section 936(a)7 provides that if a qualified domestic

     7
      Sec. 936(a) provides, in pertinent part, as follows:

     SEC. 936. PUERTO RICO AND POSSESSION TAX CREDIT.

          (a) Allowance of Credit.–-

               (1) In general.–-Except as otherwise provided in
          this section, if a domestic corporation elects the
          application of this section and if the conditions of
          both subparagraph (A) and subparagraph (B) of paragraph
          (2) are satisfied, there shall be allowed as a credit
          against the tax imposed by this chapter [chapter 1,
          relating to normal taxes and surtaxes] an amount equal
          to the portion of the tax which is attributable to the
          sum of–-

                    (A) the taxable income, from sources without
               the United States, from–-

                         (i) the active conduct of a trade or
                    business within a possession of the United
                    States, or

                         (ii) the sale or exchange of
                    substantially all of the assets used by the
                    taxpayer in the active conduct of such trade
                    or business, and

                    (B) the qualified possession source
               investment income.

               (2) Conditions which must be satisfied.–-The
          conditions referred to in paragraph (1) are:

                    (A) 3-year period.–-If 80 percent or more of
               the gross income of such domestic corporation for
               the 3-year period immediately preceding the close
               of the taxable year (or for such part of such
               period immediately preceding the close of such
                                                   (continued...)
                              - 26 -

corporation elects to have section 936 apply, then that

corporation is entitled to a credit against its income tax.   One

requirement for such treatment, as applied to the instant cases,

is that EAPR have derived at least 75 percent of its gross

income8 “from the active conduct of a trade or business within

* * * [Puerto Rico]”.

     Section 936 does not define the term “active conduct of a

trade or business”.   As far as we can tell, the Code does not

include a definition of this term as it is used in section 936.




     7
      (...continued)
               taxable year as may be applicable) was derived
               from sources within a possession of the United
               States (determined without regard to section
               904(f)); and

                    (B) Trade or business.–-If 75 percent or more
               of the gross income of such domestic corporation
               for such period or such part thereof was derived
               from the active conduct of a trade or business
               within a possession of the United States.

     Sec. 13227(a)(1) of the Omnibus Budget Reconciliation Act of
1993 (OBRA 1993), Pub. L. 103-66, 107 Stat. 321, 489, amended
sec. 936(a)(1) by striking “as provided in paragraph (3)” and
inserting “as otherwise provided in this section”. Although this
amendment applies to taxable years beginning after Dec. 31, 1993,
the amendment does not affect the substance of the above-quoted
portion of sec. 936(a). OBRA 1993, sec. 13227(f), 107 Stat. at
494. Thus, we have quoted sec. 936(a)(1) as amended by OBRA
1993.
     8
      The dispute the parties have presented to us does not focus
on the numbers. Accordingly, our analysis deals with the quality
of the activity, and not with the amount or percentage of EAPR’s
gross income from the activity.
                              - 27 -

     The term “active conduct of a trade or business” appears in

22 sections of the current version of the Code.   MedChem (P.R.),

Inc. v. Commissioner, 116 T.C. at 330.   Ordinarily, we would

expect that this term would have the same meaning in all the

places it appears.   United States v. Cleveland Indians Baseball

Co., 532 U.S. 200, 213 (2001); Commissioner v. Keystone Consol.

Industries, Inc., 508 U.S. 152, 159 (1993); United States v.

Olympic Radio & Television, 349 U.S. 232, 236 (1955); Zuanich v.

Commissioner, 77 T.C. 428, 442-443 (1981), and cases there

cited.9   However, none of the other Code provisions includes a

     9
      This is the general rule not only because of the authority
of the cited opinions, but also because this is the way
legislative drafters are instructed to draft statutes. See,
e.g., Office of the Legislative Counsel U.S. House of
Representatives, Style Manual; Drafting Suggestions for the
Trained Drafter, 3 (1989), as follows:

          (4) Use same word over and over.--If you have
     found the right word, don’t be afraid to use it again
     and again. In other words, don’t show your pedantry by
     an ostentatious parade of synonyms. Your English
     teacher may be disappointed, but the courts and others
     who are straining to find your meaning will bless you.

          (5) Avoid utraquistic subterfuges.--Do not use the
     same word in 2 different ways in the same draft (unless
     you give the reader clear warning).

     To the same effect, see Dickerson, The Interpretation and
Application of Statutes 224 (1975), quoted in Zuanich v.
Commissioner, 77 T.C. 428, 443 n.26 (1981), as follows:
           26
            See R. Dickerson, The Interpretation and
     Application of Statutes 224 (1975), as follows:

     Because legal documents are for the most part
                                                     (continued...)
                              - 28 -

statutory definition of this term.     Also, as far as we can tell,

nowhere else in the Code is there a definition of this term as it

is used in section 936 or in any of the other Code sections in

which this term is used.

     In MedChem (P.R.), Inc. v. Commissioner, 116 T.C. at 333, we

pointed out that “the roots of that section [936] are found in

section 262 of the Revenue Act of 1921”, and we briefly

summarized the purpose and history of the statute in accordance

with our analyses in G.D. Searle & Co. v. Commissioner, 88 T.C.

252, 350-351 (1987), and Coca-Cola Co. & Subs. v. Commissioner,

106 T.C. 1, 21 (1996).   From section 262 of the Revenue Act of

1921 through section 931, I.R.C. 1954, a qualifying domestic

corporation was exempt from Federal income taxes on certain

     9
      (...continued)
     nonemotive, it is presumed that the author’s language
     has been used, not for its artistic or emotional
     effect, but for its ability to convey ideas.
     Accordingly, it is presumed that the author has not
     varied his terminology unless he has changed his
     meaning, and has not changed his meaning unless he has
     varied his terminology; that is, that he has committed
     neither “elegant variation” nor “utraquistic
     subterfuge”. This is the rebuttable presumption of
     formal consistency. [Fn. refs. omitted.]

     In United States v. Cleveland Indians Baseball Co., 532 U.S.
200, 213 (2001), the Supreme Court made it clear that there are
some circumstances where “‘the meaning [of the same words] well
may vary to meet the purposes of the law,’” quoting Atlantic
Cleaners & Dyers v. United States, 286 U.S. 427, 433 (1932). It
does not appear that the circumstances dealt with in Cleveland
Indians have a persuasive parallel as to the active-conduct-of-a-
trade-or-business issue. However, see infra II. C. for
discussion of the term “manufactured or produced”.
                                - 29 -

foreign-source income.    In the Tax Reform Act of 1976, the

Congress eliminated the exemption and in its place enacted the

credit mechanism of section 936.     Tax Reform Act of 1976, Pub.L.

94-455, sec. 1051, 90 Stat. 1520, 1643.     Section 936 uses, and

each of these predecessors used, the term “active conduct of a

trade or business”.    See MedChem (P.R.), Inc. v. Commissioner,

116 T.C. at 333-336.     Also in accordance with the general

interpretation rule that statutory language should be given the

same meaning wherever it appears, we reviewed the regulations

interpreting “active conduct of a trade or business” in sections

1.179-2(c)(6), Income Tax Regs., 1.355-3(b)(2), Income Tax Regs.,

and 1.367(a)-2T(b), Temporary Income Tax Regs., 51 Fed. Reg.

17942 (May 15, 1986).     Id. at 330-333.   Synthesizing the

foregoing, we concluded as follows, id. at 336-337:

          On the basis of our understanding of the legislative
     record, we believe that Congress promulgated the “active
     conduct of a trade or business” requirement of section
     936(a) intending to prevent a domestic corporate taxpayer
     from availing itself of the possessions tax credit unless it
     established and regularly operated an employment-producing,
     profit-motivated business activity in a U.S. possession. We
     also believe that Congress expected the taxpayer to
     participate meaningfully in the management and operation of
     that activity and to invest significantly in that activity,
     the expected result of which would be to strengthen the
     economy of the possession where the activity was located. In
     light of Congress’ intent for section 936, the Secretary’s
     interpretations of the subject phrase for purposes of other
     sections of the Code, and the Supreme Court’s interpretation
     of the phrase “trade or business” in section 162(a), we
     believe that, for purposes of section 936(a), a taxpayer
     actively conducts a trade or business in a U.S. possession
     only if it participates regularly, continually, extensively,
     and actively in the management and operation of its profit-
                              - 30 -

     motivated activity in that possession. Cf. Commissioner v.
     Groetzinger, 480 U.S. [23,] 26 [(1987)]; Higgins v.
     Commissioner, 312 U.S. [212,] 217 [(l941)]; Stanton v.
     Commissioner, 399 F.2d 326, 329-330 (5th Cir. 1968), affg.
     T.C. Memo. 1967-137. We also believe that, for the purpose
     of this participation requirement, the services underlying a
     manufacturing contract may be imputed to a taxpayer only to
     the extent that the performance of those services is
     adequately supervised by the taxpayer’s own employees.

     Another source of guidance may be found in the

interpretation of “active conduct of a trade or business” in the

provisions dealing with Western Hemisphere Trading Corporations,

hereinafter sometimes referred to as WHTCs.   The WHTC provisions

existed in the Code for a substantial portion of the history of

section 936 and its predecessors.   The WHTC provisions were

enacted by sections 105(b) and 141 of the Revenue Act of 1942 as

sections 15(b) and 109, I.R.C. 1939.   Pub. L. 77-619, 56 Stat.

798, 806, 838.   Under these provisions, a domestic corporation

qualified for the WHTC exemption only if (1) all of its business

was conducted in the Western Hemisphere, (2) it derived at least

95 percent of its gross income from sources outside the United

States, and (3) it derived at least 90 percent of its gross

income “from the active conduct of a trade or business.”   Sec.

109(b), I.R.C. 1939.

     WHTCs were exempt from the corporate surtax until the

Revenue Act of 1950, Pub. L. 81-994, 64 Stat. 906, 915, 920,

which replaced the exemption (sec. 121(c) of the Act) with a

credit computed as a specified percentage of normal-tax net
                               - 31 -

income.   Sec. 122(c) of the Act.   The Internal Revenue Code of

1954 substituted for this a formula deduction resulting in a 14-

percentage-point tax rate reduction.    See sec. 922, I.R.C. 1954.

The WHTC provisions, I.R.C. 1954 secs. 921 and 922, were repealed

by sec. 1052(b) of the Tax Reform Act of 1976, Pub. L. 94-455, 90

Stat. 1520, 1648.

     Several opinions of this and other courts have noted the

general similarity of congressional purpose between the

possessions corporations provisions and the WHTC provisions.    In

view of the WHTC provisions’ use of the term “active conduct of a

trade or business”, we believe that opinions interpreting that

term as used in the WHTC provisions are helpful in interpreting

the same term in section 936(a).    As we see it, the WHTC opinions

are essentially consistent with the analysis in MedChem (P.R.),

Inc. v. Commissioner, supra.

     Section 936(a)(2)(B) requires that 75 percent of the gross

income of the qualifying corporation (in the instant cases, EAPR)

be “derived from the active conduct of a trade or business within

a possession of the United States”, in the instant cases, Puerto

Rico.   In comparison, the effect of the WHTC provisions was to

require that at least 90 percent of the gross income of the

qualifying corporation had been derived “from the active conduct

of a trade or business” in the Western Hemisphere outside of the

United States.
                                - 32 -

     Petitioners direct our attention primarily to the following

WHTC opinions:     Frank v. International Canadian Corp., 308 F.2d

520 (9th Cir. 1962); Babson Brothers Export Co. v. Commissioner,

T.C. Memo. 1963-144.    Respondent contends that “Cases arising

under * * * [the WHTC provisions] are not applicable to a section

936 issue” (a contention we reject), and urges us to focus on

“the contrary holding in another section 921 case, United States

Gypsum Company v. United States”, 304 F. Supp. 627 (N.D. Ill.

1969), affd. in part and revd. in part 452 F.2d 445 (7th Cir.

1971).

     Frank v. International Canadian Corp., supra, involved the

following situation.    A, a U.S. corporation, owned B, also a U.S.

corporation.     B produced liquid chlorine and liquid caustic soda,

which it sold to C, a Canadian corporation.    For what the

District Court found and what the Court of Appeals accepted were

“good business reasons” (id. at 526), B created D to handle sales

to C.    Thereafter, B sold its products to D, which then sold them

to C.    The Commissioner determined that D did not qualify as a

WHTC.    After losing across-the-board in a refund suit in the

District Court, the Commissioner contended on appeal that D did

not qualify as a WHTC because it did not derive the requisite

gross income “‘from the active conduct of a trade or business’

within the meaning of section 109(b) of the Internal Revenue Code
                               - 33 -

of 1939”.   Id. at 524.   The Court of Appeals summarized the

relevant facts as follows, id. at 523:

          [D] had its own invoices, letterheads, and employer
     social security number; it maintained separate books of
     account and it maintained its bank account at a bank
     different from that used by [B]; it underwent a separate
     annual audit by certified public accountants and it filed
     separate corporate income tax returns. And it had officers
     and directors differing from those of [B]; its officers and
     directors did, however, hold official positions with either
     [B] or [A].

          [D] paid one employee, Mr. Nielson, directly. Mr.
     Nielson was responsible for [D’s] administrative work. The
     work consisted of maintaining [D’s] books and records;
     reviewing all paper work done by the personnel of [B] who
     had been assigned to assist him; preparing export
     declarations and customs papers; handling correspondence;
     and coordinating instructions received from [C] with [B’s]
     traffic, production, and shipping departments. During its
     first year of operations, [D] paid [B] $100 a month for the
     assistance and facilities provided by [B]; after the first
     year was completed, a study was made and [D’s] monthly
     payment to [B] was increased to $200.

          After 1952 [D] paid Dr. William Cooper a fee to study
     the possibility of expanding [D’s] business in the Canadian
     market.

     The Court of Appeals ruled that these facts were sufficient

to constitute the active conduct of a trade or business by D,

even though the employees of B, the parent corporation, performed

all the work other than that performed by D’s one employee.     Id.

at 526-527.   The taxpayer qualified for WHTC treatment.

     In Babson Brothers Export Co. v. Commissioner, supra, we

quoted extensively from the opinion in Frank v. International

Canadian Corp., supra, and relied on the latter opinion’s

conclusions to hold that the taxpayer in Babson Brothers Export
                                - 34 -

Co. was in the active conduct of a trade or business, and

qualified for WHTC treatment.

     In Kewanee Oil Co. v. Commissioner, 62 T.C. 728, 737-738

(1974), we described as follows the essential thrust of the

foregoing cases and the significance of “active conduct of a

trade or business”:

          Although the statutory history of the Western
     Hemisphere trade corporation provisions is perhaps less
     exhaustive than might be desired, we think it nonetheless
     discloses a clearly articulated legislative purpose upon the
     basis of which Congress enacted the provisions in question.
     The critical policy which emerges in the Western Hemisphere
     provisions, and as previously expressed in the Revenue Acts
     of 1921 and 1940, was Congress’ desire to offset through a
     tax preference the competitive disadvantage suffered by
     certain American corporations abroad on account of the less
     onerous taxes to which their non-American competitors were
     subject. This encouragement was not, however, without
     limitations. By means of the source rule and the active
     conduct requirement Congress quite apparently sought to
     distinguish, however bluntly, between those corporations
     which themselves engaged in business activity outside the
     United States in direct competition with foreign
     corporations and those which merely invested in others’
     businesses abroad or otherwise did not engage in directly
     competitive activity. Our understanding in this respect is
     not different from that expressed by the few courts which
     have had occasion to address themselves to the language of
     this portion of the statute. Cf. Frank v. International
     Canadian Corporation, 308 F.2d 520, 525 (C.A. 9);13 Towne
     Securities Corporation v. Rea Forhan Pedrick, 44 A.F.T.R.
     1258, 1259 (S.D. N.Y.); Babson Bros. Export Co., 22 T.C.M.
     677, 683-684. It follows that when the “active conduct”
     requirement is read in the context from which it arose,
     namely the threat of foreign competition, one might well
     conclude that in passing the Western Hemisphere provisions
     Congress intended to grant relief to United States business
     activity in the Americas only to the extent that the
     beneficiary corporation conducted active business operations
     abroad vulnerable to the competitive threat posed by the
     tax-advantaged corporation of the other countries.14
                              - 35 -

     13
       It is quite true that the court in the International
     Canadian case stated (p. 525) that the active conduct
     requirement “is to disqualify corporations which are
     ‘inactive’ in the sense that they receive investment income
     rather than business income.” But that statement was made
     in the context of a situation where the taxpayer was engaged
     regularly and actively in the business of making sales in
     Canada, and the income in question was derived from such
     sales. The court obviously did not give any consideration
     to the applicability of the statute to an isolated
     transaction of the type before us, and we do not give that
     language the possible expansive reading that would include
     such a transaction within the “active conduct” clause.
     14
       This understanding of the statutes’ purpose conforms well
     to the Commissioner’s position that interest income, which
     would otherwise constitute “passive” income outside the
     purview of sec. 921(2), meets the “active conduct”
     requirement when received from the taxpayer’s customers on
     account of their credit obligations arising from the regular
     and recurring conduct of the taxpayer’s business. Rev. Rul.
     65-290, 1965-2 C.B. 241.

     In Kewanee Oil Co. v. Commissioner, 62 T.C. at 738, we held

that the taxpayer’s income from the sale of “substantially all of

its oil- and gas-producing property and associated equipment, the

source of virtually its entire revenues until that time” was

     derived from the termination of the major portion of its
     business and not from the active conduct thereof;
     accordingly, * * * [the taxpayer] did not meet the “active
     conduct” requirement set forth in section 921 and was
     therefore not entitled to the deduction provided in section
     922. [Id. at 739.]

     In United States Gypsum Co. v. United States, 304 F. Supp.

at 642-643, the opinion upon which respondent relies, the

District Court discussed approvingly the opinion of the Court of

Appeals for the Ninth Circuit in Frank v. International Canadian

Corp., supra.   The District Court then contrasted the factual
                             - 36 -

setting of Frank v. International Canadian Corp., supra, with its

own findings and conclusions based on the record before it, as

follows (304 F. Supp. at 643):

     Clear from a reading of the Frank rationale and holding is
     that the subsidiary there took over business previously
     performed by the parent. The parent transferred its selling
     operations to the subsidiary. The court further found there
     that the subsidiary was not “inactive”:

          “The facts also show clearly that International earned
          its income by performing services. International
          resolved shipping problems with Alaska Pine; it handled
          all the export declarations and customs papers; it
          incurred and paid $124,814.72 in freight charges; it
          was studying the possibility of expanding its business
          in Canada. In the words of the district court:

               “* * * in entire good faith International was
               organized as a corporation and at all times
               operated as a bona fide separate entity engaged in
               substantial and legitimate business activities
               from which its gross income was derived.” (308
               F.2d at 527)

          In its dealings with the affiliate mining companies
     Export performed no services; resolved no problems; incurred
     no freight charges; and engaged in no genuine business
     activities.

          I therefore find and conclude that the portion of its
     income derived from the purchase of crude gypsum from its
     sister companies and the resale to its parent was not income
     derived from the active conduct of a trade or business
     within the meaning of section 921 (26 U.S.C. §921). I
     further find and conclude that for this reason Export did
     not qualify as a Western Hemisphere Trade Corporation and
     was not entitled to claim the benefits of the special
     deductions under the Act.

     Thus, the opinion in United States Gypsum Co. v. United

States, supra, was not thought by the District Court as being

“contrary” to the rationale of Frank v. International Canadian
                              - 37 -

Corp., supra.   Rather, the difference in relevant facts in those

two cases led to the difference in result.

     In the instant cases, EAPR (1) bought, from unrelated

sellers, and owned all the equipment used in Puerto Rico to

manufacture the video games; (2) bought, from unrelated

suppliers, and owned all the raw materials and components used in

Puerto Rico to manufacture the video games; and (3) was lessee of

the facilities in Puerto Rico in which the equipment and the raw

materials and components were used in Puerto Rico in

manufacturing the video games.   EAPR’s manager lived in Puerto

Rico and worked in the leased space; he supervised PPI employees

in charge of managing materials and inventory control and saw to

it that assembly line mistakes were corrected.   The role that

EAPR played regarding video game manufacturing in Puerto Rico was

much more like what the taxpayer did in Frank v. International

Canadian Corp., supra, than what the taxpayer did in United

States Gypsum Co. v. United States, supra.

     In MedChem (P.R.), Inc. v. Commissioner, 116 T.C. at 337-

343, we discussed the factual elements that, in the aggregate,

led us to conclude that the taxpayer-subsidiary therein was not

in the active conduct of a trade or business in Puerto Rico

during the statutorily relevant 3-year time period.10   Although


     10
      See MedChem (P.R.), Inc. v. Commissioner, 116 T.C. 308,
340 (2001), where we noted that “Some of the activities listed by
[the taxpayers] preceded the 3-year period, and very few of the
                                                   (continued...)
                               - 38 -

the general fact pattern of the instant cases has some

similarities to that in MedChem, the aggregate of the differences

between the facts of MedChem and the facts of the instant cases

convinces us that the instant cases fall on the other side of the

line; i.e., that EAPR actively conducted a trade or business in

Puerto Rico during the relevant time period.    With the caution

that our conclusion is based on the aggregate of the differences

between the instant cases and MedChem; i.e., that no one

difference is critical by itself, we proceed to describe the

significant differences.

     In MedChem, the taxpayers had acquired from an unrelated

entity the assets of a Puerto Rican business that manufactured

and sold a specific pharmaceutical (hereinafter sometimes

referred to as the drug).    MedChem (P.R.), Inc. v. Commissioner,

116 T.C. at 314.   The assets were divided between taxpayer-parent

and taxpayer-subsidiary; the subsidiary is the corporation that

was claimed to qualify for the possession tax credit under

section 936(a).    Id. at 314, 327.   The taxpayer-parent got

receivables, several noncompetition agreements, goodwill,

contract rights, records, patents and related know-how,

trademarks, and Food and Drug Administration approvals.     Id. at



     10
      (...continued)
other listed activities occurred continually throughout that
period.” In the instant cases, it appears that all of the
activities that we discuss occurred during the relevant test
period.
                                - 39 -

314-315.   The taxpayer-subsidiary got receivables, inventory, and

machinery and equipment located in the unrelated entity’s

manufacturing facility.     Idem.

     As part of the sale, the unrelated entity agreed to continue

manufacturing the drug for the taxpayer-subsidiary using the

unrelated entity’s facility and labor, and using the raw

materials and equipment furnished by the taxpayer-subsidiary.

Id. at 316.   We found that the employees of the unrelated entity

“performed every task required in the manufacturing process,

including the supervision thereof, * * * without the right or

ability of * * * [the taxpayers] to manage, direct, or control

any part of the manufacturing process.”           Id. at 339.   Indeed,

except for the MedChem cases themselves, the taxpayers had

consistently reported in all instances that the unrelated entity

was the drug’s manufacturer.        Id. at 340.    As a reflection of

this, the labels which the taxpayer-subsidiary used during one of

the years at issue in MedChem designated the unrelated entity as

the manufacturer of the drug.       Id. at 315-316.     We concluded that

all of the business activities related to the manufacture of the

drug were directed and controlled by the unrelated entity out of

its Puerto Rico-based operation, and by the taxpayer-parent, out

of its U.S.-based facility.     Id. at 338.

     The taxpayer-parent distributed, marketed, and sold the drug

in the United States.     Id. at 339.    We found that the taxpayer-

subsidiary “was expressly prohibited by the processing agreement
                              - 40 -

from taking a managerial role in the manufacturing process.”      Id.

at 342.   We concluded that the substance of the work as to the

manufacturing of the drug, which required specialized skill and

expertise, was performed by the unrelated entity.    Id. at 343.

     The facts of the instant cases are distinguishable from

those in MedChem in several material respects.

     In MedChem, before the acquisition described supra, the

unrelated entity manufactured the drug in Puerto Rico, and the

taxpayer-parent did not have anything to do with the drug.     Id.

at 310-311, 314.   After this acquisition, the unrelated entity

continued to manufacture the drug at its own facility with its

own labor and was solely responsible for any problem that arose

up to the time the finished product was delivered to a carrier

for shipment to the taxpayer-parent.   Id. at 317.   Thus, although

the acquisition affected ownership, it did not affect what

happened “on the ground” in Puerto Rico.   In contrast, in the

instant cases, EA was in the entertainment software business and

relied on unrelated manufacturers in Taiwan and Japan.   After

EAPR was created, the entertainment software was manufactured in

Puerto Rico, using facilities and labor that PPI leased to EAPR,

and using equipment that EAPR bought from unrelated sellers.

Thus, the arrangements following the creation of EAPR created an

entirely new business in Puerto Rico, using facilities, labor,

and equipment that had not previously been used in this business.

In contrast to MedChem, what happened “on the ground” in Puerto
                                - 41 -

Rico in the instant cases was substantially different from the

past.

     In MedChem, we concluded that the taxpayer-subsidiary’s

        “business presence” in Puerto Rico was insignificant in
        that it did not contribute significantly to Puerto
        Rico’s economy either by creating new jobs or by
        providing capital to others to build new plants. * * *
        All of * * * [the taxpayer-subsidiary’s] business
        activities after June 30, 1990, were based in Woburn,
        * * * [Massachusetts,] and * * * [the taxpayers’]
        primary connection to Puerto Rico during that time was
        to further its efforts to move the manufacturing of
        * * * [the drug] to Woburn * * *. Id. at 338-339.

In contrast, in the instant cases, the effect of EAPR’s

operations was to transfer to Puerto Rico the manufacturing

operations that had hitherto been performed almost halfway around

the world.

        In MedChem, we found that the taxpayer-subsidiary “was

expressly prohibited by the processing agreement from taking a

managerial role in the manufacturing process.”     Id. at 342.    In

contrast, in the instant cases, PPI and EAPR agreed that (1) all

the lease employees “shall be under the general supervision of

EAPR”, and (2) “EAPR shall also supervise and control all

technical and product-related training required by” the lease

employees.     The parties’ stipulations make it clear that the EAPR

manager position was filled “at all times during the years at

issue” by “a manager who * * * worked in the leased space covered

by the Lease” and who was compensated by EAPR.     See supra table

2.   Also, it is evident that Alvarado directly supervised PPI
                              - 42 -

employees as to certain parts of the manufacturing process.    He

was not a foreman for PPI’s assembly line employees, nor did he

hire and fire them.   However: (1) He made sure that mistakes were

corrected; (2) he “[watched] out for EA’s interests” as to the

assembly work; and (3) “If things were going wrong [as to the

assembly line], then PPI would call me in for assistance.”

     In MedChem (P.R.), Inc. v. Commissioner, 116 T.C. at 338

n.14, we stated as follows:
     14
       We distinguish Frank v. International Canadian Corp., 308
     F.2d 520 (9th Cir. 1962), a case cited by petitioners to
     support their assertion that MedChem P.R. actively conducted
     a trade or business by virtue of its sales activity. The
     relevant holding in Frank concerned whether the taxpayer
     actively conducted a trade or business and did not concern
     where that trade or business was located.

     In the instant cases, EAPR’s activities in Puerto Rico with

respect to the video games are critically different from the

taxpayer’s activities in MedChem (P.R.), Inc. v. Commissioner,

supra (where the taxpayer’s only activities in Puerto Rico were

the taking of steps to move the business from Puerto Rico to

Massachusetts), and Kewanee Oil Co. v. Commissioner, supra (where

substantially all the taxpayer’s relevant income was derived from

the sale of substantially all the taxpayer’s relevant business).

     Our findings (supra I.F.) lead us to conclude that EAPR,

through its manager, participated regularly, continually,

extensively, and actively in the management and operation of the

manufacturing of video games in Puerto Rico.
                                - 43 -

     In view of the foregoing, we conclude that EAPR actively

conducted a trade or business in a U.S. possession within the

meaning of section 936(a)(2)(B).

4.   Respondent’s Other Contentions

      a.   Genuine Issues of Material Fact

                        i. Place of Manufacture

      Respondent contends as follows on opening brief:

      2.    There is a factual dispute as to where the video
            games were manufactured. * * * Whether video
            games were manufactured in the Dominican Republic
            or Puerto Rico is a crucial factor in ascertaining
            whether EAPR was engaged in the active conduct of
            a trade or business in Puerto Rico.

On answering brief, respondent objects to petitioners’ proposed

finding of fact that “The video games at issue that EA purchased

from EAPR were manufactured in Puerto Rico. [Stip. ¶ 27]”, as

follows:

           22. Objection. The evidence establishes that the
      video games that EA purchased from EAPR were manufactured by
      PPI employees in PPI’s Dominican Republic facilities as well
      as in PPI’s Puerto Rico facilities. See RRPSOF ¶ 17.

      However, the parties stipulated as follows:   “27.   The video

games at issue that EA purchased were manufactured in Puerto

Rico.”     Note that respondent does not contend that EA bought the

video games from PPI; respondent accepts petitioners’ contention

that EA bought the video games from EAPR.    Respondent’s only

objection is as to the geographic location of the manufacturing--

the very point that the parties resolved by their stipulation.
                             - 44 -

     Rule 91(e) provides, in pertinent part, as follows:

          (e) Binding Effect: A stipulation shall be
     treated, to the extent of its terms, as a conclusive
     admission by the parties to the stipulation, unless
     otherwise permitted by the Court or agreed upon by
     those parties. The Court will not permit a party to a
     stipulation to qualify, change, or contradict a
     stipulation in whole or in part, except that it may do
     so where justice requires. * * *

     Respondent has not asked to be relieved from this

stipulation, and nothing that has been brought to the Court’s

attention leads us to conclude that justice requires us, sua

sponte, to relieve respondent from this stipulation.     Compare the

instant cases with, e.g., BankAmerica Corp. v. Commissioner, 109

T.C. 1, 12 (1997) (where we concluded that, in the interest of

justice, the taxpayer should be relieved from the effects of a

stipulation, but only for a specified “narrow purpose”); Stamos

v. Commissioner, 87 T.C. 1451, 1454-1456 (1986) (where we

“concluded that the language in question from the stipulation

filed herein is so ambiguous and indefinite that it does not

constitute a stipulation at all”, and thereupon denied a motion

for partial summary judgment).

     Respondent explains the stipulation as follows:

     The stipulations listed by Petitioners do not preclude
     evidence that part of the games were manufactured elsewhere,
     e.g., the Dominican Republic, since they refer only to what
     has taken place in Puerto Rico and do not address activities
     outside Puerto Rico.

     The effect of this explanation is to treat Stipulation 27 as

though it read as follows:
                              - 45 -

          27. The video games at issue that EA purchased were
     manufactured in Puerto Rico, except to the extent they were
     manufactured in the Dominican Republic.

     We refuse to allow respondent to unilaterally reform the

filed stipulation in this matter.   We do not accept respondent’s

unilateral explanation that the stipulation means so much less

than it appears to mean.

     We conclude that there is no genuine issue as to the

material fact of Puerto Rican manufacture of the relevant video

games.

             ii.   Control Over Manufacturing Process

     Respondent contends as follows:

     3.   There is a factual dispute as to whether EAPR had any
          control over the manufacturing process. According to
          Alvarado, there were significant conflicts between EA
          and PPI because EA did not want the video games to be
          manufactured at PPI’s plant in the Dominican Republic.
          Alvarado Decl. ¶¶ 34-35. The manufacturing was done by
          PPI workers in the Dominican Republic because it was
          cheaper. Alvarado Decl. ¶ 22. Obviously, if EA (or
          EAPR) had been in control of the manufacturing process,
          the video games would not have been manufactured in the
          Dominican Republic by PPI against EA’s wishes. Whether
          EAPR had any control over the manufacturing process is
          directly related to the issue of whether EAPR
          controlled and supervised the PPI employees. [Fn. ref.
          omitted.]

     This asserted genuine issue of material fact is bottomed on

the contention of Dominican Republic manufacture.   As we have

pointed out supra, i. Place of Manufacture, the parties’

stipulation has foreclosed this contention.   Thus, this
                               - 46 -

contention as to EAPR’s control over the manufacturing process is

not a genuine issue as to a material fact.

             iii.    Supervision Over Lease Employees

     Respondent contends as follows:

     1.   There is a factual dispute as to whether the one EAPR
          employee (i.e., Willie Zamora, Jose Cruz, or Miguel
          Orlando Alvarado) supervised or controlled the PPI
          employees who manufactured the video games or the EA
          employees who performed all of EAPR’s daily operations.

     Respondent relies primarily on Alvarado’s declaration, which

respondent offered in support of respondent’s opposition to

petitioners’ motion.   Alvarado’s declaration indicates that he

was EAPR’s manager for most of the period before the Court.

Alvarado’s declaration states that

          (1) he oversaw the transferring of raw materials, work

     in process, and finished goods, and in this capacity he “had

     two or three PPI employees under me in the materials

     management function”; and

          (2) he--

     also oversaw the PPI employees who worked on inventory
     control, which meant that I had to make sure that they were
     doing the cycle counts and that they entering [sic] the
     correct data onto paper inventory reports. I was
     responsible for entering the data into the computer. I
     oversaw that the correct data was entered into the computer
     for [MRP System] on the Puerto Rican end. * * *

     In general I did not deal directly with assembly line
     operation, since this was handled by PPI. However, if I saw
     a mistake being made, then I would see that it got
     corrected. My basic function in regard to the assembly work
     was to watch out for EA’s interests. However, PPI handled
     the daily production requirements and PPI scheduled the
                             - 47 -

     employees, assigned positions to them, handled things on the
     assembly floor, took care of sick leave and other personnel
     problems. If things were going wrong, then PPI would call
     me in for assistance. Otherwise, PPI handled everything.

     Respondent also relies on Cruz’ declaration, which is as

follows, in entirety:

     1.   I reside at Calle Leonor AV 21, 4th Extension,
          Levittown Lakes, Puerto Rico 00949.

     2.   I was employed by Electronic Arts Puerto Rico for a
          period of 3 ½ weeks in the summer of 1993.

     3.   I was hired about two weeks before the death of Mr.
          Zamora as his assistant.

     4.   I never held the position of General Manager nor did I
          ever carry out the duties of General Manager.

     5.   The focus of my work as assistant to Mr. Zamora was
          with inventory control, particularly counting
          inventory, communicating with Electronic Art [sic] in
          California in regard to inventory needs, and I also had
          some responsibilities with regard to shipping.

     6.   My employment was terminated 1 ½ weeks after Zamora
          died.

     Respondent further contends that “Absent first hand evidence

of the business practices prior to Cruz and Alvarado, Respondent

is entitled to the inference that the same business practices

were in effect while Zamora was employed at EARP [sic].”

     As we have noted supra (in note 6, and in the description in

II. A. In General, of the affidavits and declarations that the

parties submitted), for purposes of the instant partial summary

judgment motion, we have treated the statements as to matters of

fact in the Alvarado declaration as though (1) they accurately
                             - 48 -

describe the events they deal with, and (2) the events that

occurred before Alvarado was hired were consistent with these

statements--except, of course, to the extent that the statements

are contrary to the parties’ stipulations.    We give little weight

to the Cruz declaration’s account of the 2 weeks when he was

Zamora’s assistant and the 1-1/2 weeks after Zamora’s death.

     We conclude from the foregoing that, for the period before

the Court, EAPR’s employees provided substantial supervision to

the PPI employees (the lease employees) who did the video game

manufacturing for EAPR in Puerto Rico.    Although there is room

for further factual development, the material offered by

respondent leads us to the conclusion that, if any such

development were to show us that respondent’s proffered materials

fully and accurately described the facts, then we would conclude

that the supervision requirement of MedChem has been satisfied.

     In other words, on this issue, petitioners win on the facts

as described in respondent’s materials.    Thus, although there may

be a genuine issue as to the extent of EAPR’s supervision of the

manufacturing process, there is not a genuine issue as to a

material fact with regard to EAPR’s qualification for possession

tax credits for the years in issue.
                              - 49 -

     b.   EAPR Ineligible As a Matter of Law

                           i. WHTC Cases

     Respondent contends that “Cases arising under section 921

and 922 [the Western Hemisphere Trade Corporation provisions] are

not applicable to a section 936 issue.     See Norfolk Southern

Corp. [v. Commissioner,] 104 T.C. [13] at 41 [(1995)].”

     Firstly, the cited opinion, Norfolk S. Corp. v.

Commissioner, 104 T.C. 13, modified 104 T.C. 417 (1995), affd.

140 F.3d 240 (4th Cir. 1998), neither states nor stands for the

proposition for which respondent cites it.     The cited opinion

does not even involve or cite sections 921, 922, or 936 or their

predecessors.11


     11
      Norfolk S. Corp. v. Commissioner, 104 T.C. 13, modified
104 T.C. 417 (1995), affd. 140 F.3d 240 (4th Cir. 1998), was an
investment credit case; it did not involve the WHTC provisions or
the possession tax credit provisions. Respondent directs our
attention to Norfolk S. Corp. v. Commissioner, 104 T.C. at 41.
That page is part of our analysis of the taxpayer’s contention
that “used” in the phrase “used in the transportation of
property” in sec. 48(a)(2)(B)(v), must be given the same meaning
as in the phrase “used in the trade or business” in sec.
167(a)(1). We concluded that, in the context of sec.
48(a)(2)(B)(v), it made sense to give “used” a different meaning
from “used” in the context of sec. 167(a)(1). We buttressed our
conclusion as follows, Norfolk S. Corp. v. Commissioner, 104 T.C.
at 40 n.30:
     30
       We note in further support of our rejection of
     petitioners’ interpretation of the container exception that
     in sec. 48(a)(2)(B)(v) Congress employed the phrase “used in
     the transportation of property”, not “used in the trade or
     business of transporting property”. “The use of different
     phrases may reasonably be viewed as an indication of two
     different meanings.” Pavelic & LeFlore v. Marvel
                                                   (continued...)
                              - 50 -

     Secondly, respondent’s brief does not present to us, or

direct our attention to, an analysis to support the proposition

that WHTC opinions “are not applicable to a section 936 issue.”

     Thirdly, as opinions of this and other courts have shown,

the histories of WHTC legislation and possessions corporation

legislation have been intertwined for the entire history of the

WHTC provisions.   See, e.g., Kewanee Oil Co. v. Commissioner, 62

T.C. 728, 735-738 (1974), and opinions cited therein, affd.

without published opinion 517 F.2d 1398 (3d Cir. 1975) (a WHTC

“active conduct of a trade or business” case in which the 1921

Act predecessor of section 936 is described as having “laid the

conceptual groundwork,” for, among other provisions, the WHTC

provisions); Burke Concrete Accessories, Inc. v. Commissioner, 56

T.C. 588, 596-599 (1971), and opinions cited therein (a

consolidated return case in which a section 1504(b)(4) reference

to section 931 is construed by taking into account the agreement

of the parties that the corporation there involved was both a

WHTC and a possessions corporation).   This intertwining of


     11
      (...continued)
     Entertainment Group, 493 U.S. 120, 128 (1989) (Marshall, J.,
     dissenting); see also LaCroix v. Commissioner, 61 T.C. 471
     (phrase “tangible personal property” interpreted for
     purposes of sec. 179).

The same point, that differences in statutory terminology
ordinarily lead to the conclusion of differences in meaning, is
also made in Berry Petroleum Co. & Subs. v. Commissioner, 104
T.C. 584, 646 n.41 (1995), affd. without published opinion 142
F.3d 442 (9th Cir. 1998). See supra note 9.
                              - 51 -

historical development increases the likelihood that the Congress

was actually aware that “active conduct of a trade or business”

figured in both the WHTC provisions and in section 936.

     In light of the foregoing, we reject respondent’s contention

that WHTC cases “are not applicable to a section 936 issue”, and

we conclude that respondent’s citation of Norfolk S. Corp. v.

Commissioner, supra, does not provide any support for

respondent’s contention.   On the contrary, we regard WHTC

opinions as authority with respect to the meaning of identical

language in section 936.

                    ii. Expressio Unius * * *

     Respondent contends as follows:

          “There is a venerable rule of statutory construction
     which states: expressio unius est exclusio alterius (the
     expression of one thing implies the exclusion of another
     thing).” Section 936(a)(2)(B) does not refer to attribution
     of activities, such as contract manufacturing; however,
     section 936(h)(5)(B)(iii)(II) does refer to “contract
     manufacturing.” “Where Congress includes particular
     language in one section of a statute but omits it in another
     section of the same [statute], it is generally presumed that
     Congress acts intentionally and purposely in the disparate
     inclusion or exclusion.”

          In choosing the words “such domestic corporation” as
     the statutory standard in section 936(a)(2)(B), without
     reference to attribution of another’s activities, such as
     the activities of a contract manufacturer, Congress limited
     consideration exclusively to the domestic corporation’s
     conduct in the possession. In other words, the activities
     of others cannot be attributed to the domestic corporation
     for purposes of section 936(a)(2)(B). [Citations omitted.]

     In effect, the “expressio unius” rule to which respondent

draws our attention is merely the obverse of what we have
                              - 52 -

discussed supra note 9 and accompanying text.   Ordinarily, in

statutes and other legal documents, it is presumed that if the

drafter uses the same terminology in several places then the

drafter intends the same meaning in each such place.   By the same

token it is presumed that if the drafter varies the terminology

then the drafter intends that the meaning also varies.   Or, as

Dickerson put it in the Interpretation and Application of

Statutes 224 (1975), it is presumed that the drafter “has

committed neither ‘elegant variation’ nor ‘utraquistic

subterfuge’.”

      A problem with the “expressio unius” rule is that, although

the rule tells us that a different meaning is probably intended,

it often is difficult to determine what that different meaning

is.   See, e.g., Black’s Law Dictionary 602 (7th ed. 1999).    The

instant cases illustrate how the party that invokes this rule can

find that the rule favors the other side.   See, e.g., Ginsburg,

“Making Tax Law Through the Judicial Process,” 70 A.B.A.J. 74, 76

(1984).

      In general, section 936(h) deals with the treatment of

intangible property income.   It provides that the domestic

shareholders of a qualified domestic corporation which elects the

possession tax credit are required to include in their gross

income as of the close of the electing corporation’s tax year

their pro rata share of the possessions corporation’s intangible
                              - 53 -

property income as United States source income unless an election

out is made by the possessions corporation.    Sec. 936(h)(1)(A).

However, the general rule of possessions corporations is

inapplicable if an eligible possessions corporation elects out of

its provisions by electing to use either the cost sharing method

or the profit split method for computing its taxable income.

This election may be made under section 936(h)(5).    For purposes

of subparagraph (B) of section 936(h)(5), costs incurred by the

electing corporation or a member of its affiliated group in

connection with contract manufacturing by a person other than a

member of the affiliated group are not treated as production

costs of the electing corporation in the possession or as direct

material costs or as compensation for services performed in the

possession.   Sec. 936(h)(5)(B)(iii)(II).   Rather, they are

treated as the direct labor costs of the affiliated group.     Id.

     The effect of the term “contract manufacturing” in section

936(h)(5)(B)(iii)(II) is to make it more difficult to establish a

substantial business presence in a possession--within the meaning

of section 936(h)(5)(B)(i)--when the possessions corporation uses

contract manufacturing for its manufacturing activities.    The

term appears in a rule which is statutorily directed to apply

“For purposes of this subparagraph,” that is, subparagraph (B) of

section 936(h)(5).   Thus, when examined in context, the

“expressio unius” canon of construction suggests that contract
                              - 54 -

manufacturing is to be given a special unfavorable (for the

taxpayer) effect only for purposes of section 936(h)(5)(B), and

that for all other section 936 purposes contract manufacturing is

not to be given an effect unfavorable to the taxpayer.   It

follows that the canon of construction that respondent urges upon

us does not lead to the result for which respondent contends, but

rather (when the context is considered) it supports the result

for which petitioners contend.

              iii. Plain Meaning; Legislative History

     Respondent contends that the plain meaning of “such domestic

corporation” in the statute, and the plain meaning of “it” and

“its gross income” in the report of the Senate Finance Committee,

lead to the conclusion that “only the possessions corporation’s

conduct can be considered for purposes of satisfying the active

business requirement.”

     The same statutory language has been in the predecessors of

section 936 since the initial enactment--section 262 of the

Revenue Act of 1921, Pub. L. 67-98, 42 Stat. 227, 271.   The same

statutory language was in the WHTC provisions--sec. 109, I.R.C.

1939.   Essentially the same argument was presented to, and

rejected by, the Court of Appeals for the Ninth Circuit in Frank

v. International Canadian Corp., 308 F.2d at 526-527.    In our

recent opinion in MedChem (P.R.), Inc. v. Commissioner, 116 T.C.
                             - 55 -

at 337, we interpreted the statute to allow attribution of the

services of nonemployees if certain conditions are satisfied.

     Thus, the courts have interpreted this language to not

preclude attribution as a matter of law, but rather as permitting

attribution or not depending on the factual setting.    A careful

examination of respondent’s contention that the plain meaning of

the statute and its legislative history precludes attribution

leads us to conclude that such a plain meaning cannot be drawn

from the statute and its legislative history.

5. Holding

     We conclude that EAPR’s manufacturing arrangement in Puerto

Rico met the requirements of the section 936 active-conduct-of-a

-trade-or-business test as we interpreted it in MedChem.     This is

a highly factual determination.   Frank is also persuasive in this

context.

     Further, we conclude that petitioners have met their burden

of showing that there is not any genuine issue as to any material

fact with respect to whether EAPR actively conducted a trade or

business in Puerto Rico within the meaning of section

936(a)(2)(B).

     Accordingly, we hold that petitioners are entitled to

summary judgment on this issue.
                               - 56 -

                 C.   Significant Business Presence

1.   The Statutory Setting of the Dispute

     If a possessions corporation has “intangible property

income”, then that income is generally treated as income of the

possessions corporation’s shareholders, in accordance with rules

set forth in section 936(h).   However, a possessions corporation

may “elect out” under section 936(h)(5)12 and choose to compute


     12
      Par. (5) of sec. 936(h) provides, in pertinent part, as
follows:

                (5) Election Out.–-

                     (A) In general.--The rules contained in
                paragraphs (1) through (4) do not apply for any
                taxable year if an election pursuant to
                subparagraph (F) is in effect to use one of the
                methods specified in subparagraph (C).

                      (B) Eligibility.--

                           (i) Requirement of significant business
                      presence.–-An election may be made to use one
                      of the methods specified in subparagraph (C)
                      with respect to a product or type of service
                      only if an electing corporation has a
                      significant business presence in a possession
                      with respect to such product or type of
                      service. An election may remain in effect
                      with respect to such product or type of
                      service for any subsequent taxable year only
                      if such electing corporation maintains a
                      significant business presence in a possession
                      with respect to such product or type of
                      service in such subsequent taxable year. If
                      an election is not in effect for a taxable
                      year because of the preceding sentence, the
                      electing corporation shall be deemed to have
                      revoked the election on the first day of such
                      taxable year.
                                                     (continued...)
                           - 57 -



12
     (...continued)
                       (ii) Definition.--For purposes of this
                  subparagraph, an electing corporation has a
                  “significant business presence” in a
                  possession for a taxable year with respect to
                  a product or type of service if:

                            (I) the total production costs
                       (other than direct material costs and
                       other than interest excluded by
                       regulations prescribed by the Secretary)
                       incurred by the electing corporation in
                       the possession in producing units of
                       that product sold or otherwise disposed
                       of during the taxable year by the
                       affiliated group to persons who are not
                       members of the affiliated group are not
                       less than 25 percent of the difference
                       between (a) the gross receipts from
                       sales or other dispositions during the
                       taxable year by the affiliated group to
                       persons who are not members of the
                       affiliated group of such units of the
                       product produced, in whole or in part,
                       by the electing corporation in the
                       possession, and (b) the direct material
                       costs of the purchase of materials for
                       such units of that product by all
                       members of the affiliated group from
                       persons who are not members of the
                       affiliated group; or

                            (II) no less than 65 percent of the
                       direct labor costs of the affiliated
                       group for units of the product produced
                       during the taxable year in whole or in
                       part by the electing corporation or for
                       the type of service rendered by the
                       electing corporation during the taxable
                       year, is incurred by the electing
                       corporation and is compensation for
                       services performed in the possession; or

                            (III) with respect to purchases and
                       sales by an electing corporation of all
                                                 (continued...)
                                - 58 -

its relevant taxable income under one of the methods described in

section 936(h)(5)(C)--the cost sharing method or the profit split

method--but only if the possessions corporation “has a

significant business presence” in a possession.     Sec.

936(h)(5)(B)(i).     Section 936(h)(5)(B)(ii) provides that a

possessions corporation “has a ‘significant business presence’”

in a possession if the corporation satisfies any one of three

statutory tests.     These three tests are (1) the 25-percent-value

-added test, (2) the direct-labor-production test, and (3) the



     12
          (...continued)
                            goods not produced in whole or in part
                            by any member of the affiliated group
                            and sold by the electing corporation to
                            persons other than members of the
                            affiliated group, no less than 65
                            percent of the total direct labor costs
                            of the affiliated group in connection
                            with all purchases and sales of such
                            goods sold during the taxable year by
                            such electing corporation is incurred by
                            such electing corporation and is
                            compensation for services performed in
                            the possession.

                       Notwithstanding satisfaction of one of the
                       foregoing tests, an electing corporation
                       shall not be treated as having a significant
                       business presence in a possession with
                       respect to a product produced in whole or in
                       part by the electing corporation in the
                       possession, for purposes of an election to
                       use the method specified in subparagraph
                       (C)(ii), [the profit split method] unless
                       such product is manufactured or produced in
                       the possession by the electing corporation
                       within the meaning of subsection (d)(1)(A) of
                       section 954.
                               - 59 -

direct-labor test for purchases and resales, set forth in

subclauses (I), (II), and (III), respectively, of section

936(h)(5)(B)(ii).   However, the final flush language of section

936(h)(5)(B)(ii) provides that, if the possessions corporation

claims the profit split method with respect to a product that the

possessions corporation produces in whole or in part in the

possession, then the possessions corporation does not have a

significant business presence in that possession--

     unless such product is manufactured or produced in the
     possession by the electing corporation within the
     meaning of subsection (d)(1)(A) of section 954.

     Respondent refers to the alternative tests set out in the

three subclauses of section 936(h)(5)(B)(ii) as “the first

prong”, and refers to the test set out in the final flush

language of section 936(h)(5)(B)(ii) as “the second prong”.    That

terminology appears to be helpful, and we use it in the instant

opinion.

2.   Parties’ Contentions

      Many of the parties’ contentions on this issue are similar

to those that they made with respect to the active-conduct-of-a-

trade-or-business issue.    In particular, respondent contends that

petitioners’ partial summary judgment motion must be denied

because (1) “as a matter of law * * * Petitioners cannot

attribute the activities of the PPI [employees] or EA employees

to EAPR” to satisfy the significant-business-presence test under
                               - 60 -

section 936(h)(5)(B), and (2) if attribution is not per se

impermissible, then “there are material facts in dispute that are

relevant to the statutory” test.   As to attribution, respondent

contends that (a) it is contrary to the plain meaning of the

statutory text; (b) it violates the “firmly established rule of

statutory construction that states: expressio unius est exclusio

alterius (the expression of one thing implies the exclusion of

another thing)”; (c) the legislative history shows that the

Congress did not intend to permit attribution to satisfy the

profit split method; and (d) absent attribution, EAPR’s own

activities do not constitute the manufacture or production of the

video games.

     Respondent urges that the “Congress did not intend its

reference [in sec. 936(h)(5)(B)(ii) (final flush)] to section

954(d)(1) to lessen the requirement that the corporation electing

the profit split method must manufacture the product”, without

“taking into account the activities of a contract manufacturer.”

Also, respondent contends, the Court should not take into account

respondent’s interpretation of section 954 in Rev. Rul. 75-7,

1975-1 C.B. 244.13   Respondent contends that, if attribution is


     13
      Interestingly, respondent includes the following among the
reasons why we should not rely on Rev. Rul. 75-7, 1975-2 C.B.
244, even though that ruling was extant when sec. 936(h) was
enacted:

     In Ashland Oil, [95 T.C. 348 (1990)], the court stated:
                                                   (continued...)
                              - 61 -

not prohibited as a matter of law, then there are the following

genuine issues of material fact:   (a) Whether the video games

were manufactured in Puerto Rico or in the Dominican Republic;

and (b) “exactly what level of involvement in Puerto Rico EAPR

had in the manufacturing process   * * * and whether that level of

manufacturing activity is significant enough to permit the

attribution of the activities of the PPI employees to EAPR for

purposes of the significant business presence test.”

     Petitioners contend that EAPR satisfied the first prong of

the significant business presence test by satisfying the direct

labor test of section 936(h)(5)(B)(iii)(II).   Petitioners contend

that EAPR satisfied the second prong of the significant business

presence test, and thus is eligible to use the profit split

method, because EAPR met all the manufacturing requirements of

section 1.954-3(a)(4), Income Tax Regs.   Petitioners maintain

that PPI was not the manufacturer within the meaning of the cited

regulation.   Petitioners also rely on the inventory provisions

(sections 471 and 263A, and the regulations thereunder, and Rev.


     13
      (...continued)
     “Revenue rulings represent only the Commissioner’s
     position concerning specific factual situations, rather
     than substantive authority for deciding a case in this
     court.” Id. at 360. Other courts have similarly held
     that revenue rulings are not binding on the
     Commissioner, the Secretary or the courts. Schuster v.
     Commissioner, 800 F.2d 627 (7th Cir. 1986), aff’g 84
     T.C. 764 (1985), citing Dickman v. Commissioner, 465
     U.S. 330 (1984); Stubbs, Overbeck & Associates v.
     United States, 445 F.2d 1142 (5th Cir. 1971).
                                - 62 -

Rul. 81-272, 1981-2 C.B. 116) and on Rev. Rul. 75-7, 1975-2 C.B.

244, to show that EAPR was the manufacturer.   Petitioners contend

that what EAPR did satisfied the congressional purpose of

creating jobs in Puerto Rico.

     In response to respondent’s “expressio unius” contentions,

petitioners maintain that the Congress’s inclusion of “contract

manufacturing” as a consideration in section

936(h)(5)(B)(iii)(II) that limits the ability of a corporation to

qualify for significant business presence treatment, should

properly lead to a conclusion that contract manufacturing does

not otherwise limit the ability of a corporation to so qualify.

     In response to respondent’s contention that the video games,

or some of them, were manufactured in the Dominican Republic,

petitioners rely on the stipulation that the video games were

manufactured in Puerto Rico.

     On opening brief, petitioners state that EAPR satisfied the

first prong “and Respondent does not contend otherwise.”

Respondent states that “Respondent did not contend otherwise,

however, until having obtained the unsigned Declaration of Miguel

Orlando Alvarado.”   The only objection that respondent then

states as to the first prong is that “it is highly likely that

some of the direct labor costs claimed by Petitioners to have

been expended in the possession were really expended in the

Dominican Republic.”
                               - 63 -

3.   Summary of Conclusions

      As we have stated supra (B.4.a.i. Place of Manufacture), we

view the parties’ stipulations differently than respondent.     In

the relevant stipulations--executed and filed 9 days after

respondent completed the Alvarado Declaration that respondent

submitted in opposition to petitioners’ summary judgment motion--

the parties have agreed that “the video games at issue” were

manufactured in Puerto Rico.   This precludes respondent from

contending that, to some extent, the video games that are

relevant in the instant cases were manufactured in the Dominican

Republic or any place else other than Puerto Rico.   Thus, the

only predicate of respondent’s only challenge to EAPR’s

satisfaction of the first prong drops out, and petitioners are

entitled to partial summary judgment that EAPR satisfied the

first prong.

      This leaves the second prong as the only bone of contention

on this issue, whether EAPR satisfies the requirement that the

video games were “manufactured or produced” in Puerto Rico “by”

EAPR “within the meaning of subsection (d)(1)(A) of section 954.”

      Our examination of (1) section 936(h)(5)(B)(ii) and the

legislative history of that provision’s enactment in 1982, and

(2) section 954(d)(1)(A) and the legislative history of that

provision’s enactment in 1962, convinces us that there is not an

absolute requirement that only the activities actually performed
                               - 64 -

by a corporation’s employees or officers are to be taken into

account in determining whether the corporation manufactured or

produced a product in a possession, within the meaning of

sections 936(h)(5)(B)(ii) (final flush) and 954(d)(1)(A).

     By the same token, petitioners’ focus on certain language in

section 1.954-3(a)(4), Income Tax Regs., overlooks the

regulation’s requirement that various actions have been done “by”

the corporation being evaluated.   Also, because of our evaluation

in Spalding v. Commissioner, 66 T.C. 1017 (1976), we conclude

that the Code’s inventory provisions that petitioners rely on are

not good precedents for interpreting “manufactured or produced”

within the meaning of section 954(d)(1)(A).

     In light of our rejection of both sides’ views of the law,

we conclude that proper evaluation of the merits of the instant

cases requires a fuller development of the facts and perhaps a

fuller exposition of the law consistent with the views we have

expressed in this opinion.   Under these circumstances, we

conclude that petitioners have failed to carry their burden of

proving that they are entitled to summary judgment as to the

second prong.

4.   Analysis

      The dispute as to the second prong centers on the meaning of

the final flush language of section 936(h)(5)(B)(ii), requiring

that the product have been--
                                 - 65 -

     (a)   manufactured,

     (b)   in Puerto Rico,

     (c)   by EAPR,

and that this have been done “within the meaning of subsection

(d)(1)(A) of section 954.”

     Ordinarily, if we do not have a clear authoritative

interpretation of this language in section 936(h)(5)(B)(ii)

(final flush), then we would examine other Code provisions that

use the same language and treat interpretations of any such Code

provisions as authoritative, or at least highly persuasive,

definitions of this language.     See, e.g., supra note 9 and

accompanying text, and our analysis of the meaning of “active

conduct of a trade or business”.     However, we have held that the

terms “manufactured” and “produced” are not to be so analyzed.

     In Spalding v. Commissioner, 66 T.C. 1017 (1976), the

taxpayers constructed an 8-foot chain link fence around that

portion of their auto wrecking yard in which their employees

dismantled autos and stored salvaged parts.      Id. at 1019.    The

issue before us was whether this fence qualified for the

investment credit.    Id.    In order to resolve this issue we had to

decide whether the taxpayers’ activity constituted

“manufacturing” or “production” within the meaning of section

48(a)(1)(B)(i), I.R.C. 1954.     We opined that the taxpayers’

activity apparently would not constitute manufacturing or

production under section 954(d)(1)(A) but would under section
                                - 66 -

341.    66 T.C. at 1020-1021.   We concluded as follows, id. at

1021:

            Therefore we conclude that “manufacturing” and
       “production” have no uniform generalized meaning in the
       Code and we must look to the purposes and legislative
       history of section 48 for their specific meaning here.

To the same effect, see Garnac Grain Co. v. Commissioner, 95 T.C.

7, 30-31 (1990).

       As best we can tell, we are most likely to give the same term

different meanings in different places (i.e., to conclude that the

drafter committed a “utraquistic subterfuge”, whether intentionally

or by mistake) if the term is short (e.g., the one-word terms

“manufacturing” and “production”) and is used in common (i.e.,

nonlegal) speech with a variety of meanings.    In any event, it is

clear that, as to “manufactured” and “produced”, we must focus on

the sections directly before us, and we are not likely to draw much

assistance from the interpretation of those words as they appear in

other statutes.    However, see discussion infra (a. Legislative

History--Sec. 936(h)), where a portion of the 1982 Act explanation

by the conference committee states as follows:

       In general, the figures to be used for these calculations [the
       first prong tests] will be those used by the island affiliate
       and its affiliates in their required inventory calculations.
       [H. Conf. Rept. 97-760, 506, 1982-2 C.B. 600, 619.]

       On this issue, also, respondent makes the “expressio unius”

contention that the reference to “contract manufacturing” in

section 936(h)(5)(B)(iii)(II), and the treatment of that subject

in section 1.936-5(c), Q&A-3, Income Tax Regs., mean that
                               - 67 -

contract manufacturing is not to be taken into account for any

other purposes, including specifically the analysis of whether

the possessions corporation is the manufacturer for purposes of

our second prong analysis.   Respondent takes the position that

both the cited statute and the cited regulation apply only to the

first prong.

     On the basis of the analysis set forth supra (B.4.b.ii),

relating to the “active conduct of a trade or business” issue, we

conclude that respondent’s contention favors petitioners to some

extent.   That is, the presence of a restriction on contract

manufacturing when evaluating the first prong, and the absence of

that term in the second prong, may mean that contract

manufacturing is not restricted under the second prong.

     Neither side has drawn our attention to, and we have not

found, caselaw interpreting the provisions of either section

936(h)(5)(B)(ii) or section 954(d)(1)(A) as relevant to the

instant cases.14   Accordingly, we examine the origins of these


     14
      See, e.g., Vetco, Inc. v. Commissioner, 95 T.C. 579, 594
(1990), in which we ruled that we would “not address whether
* * * [the subsidiary corporation] was engaged in manufacturing”,
because our determination under sec. 954(d)(2) made it
unnecessary to answer the manufacturing question. See also id.
at 580.

     In Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C.
338 (1972), we held that activities of a subsidiary of the
taxpayer amounted to manufacturing within the meaning of sec.
954(d)(1)(A). In Webb Export Co. v. Commissioner, 91 T.C. 131
(1988), we concluded that activities of a taxpayer amounted to
production within the meaning of sec. 954(d)(1)(A), and we held
                                                   (continued...)
                               - 68 -

provisions in order to determine whether we can conclude that

petitioners are entitled to summary judgment on the matter before

us.

      a.   Legislative History--Sec. 936(h)

      Subsection (h) was added to section 936 by section 213(a)(2)

of the Tax Equity and Fiscal Responsibility    Act of 1982

(hereinafter sometimes referred to as TEFRA 82), Pub. L. 97-248,

96 Stat. 324, 452.    The bill (H.R. 4961) as passed by the House

of Representatives did not have a provision corresponding to

subsection (h).    H. Conf. Rept. 97-760, at 504 (1982), 1982-2


      14
      (...continued)
as a result that these activities amounted to production within
the meaning of sec. 993(c)(1)(A). In each of these cases it
appears that all the relevant work was done directly by employees
of the company whose qualifications were in dispute. The
question before the Court in each of those cases was whether
there was manufacturing or producing. In the instant cases,
respondent states on answering brief: “Respondent does not
dispute that there was manufacturing. The issue is, rather, who
did the manufacturing.” We do not believe that either Dave
Fischbein Manufacturing Co. or Webb Export Co. is helpful in
deciding whether EAPR manufactured or produced the video games
here in dispute; neither side cites either of those opinions.
Both sides cite Bausch & Lomb, Inc. v. Commissioner, T.C. Memo.
1996-57. We conclude that that opinion is not helpful in
resolving the issue presented in the instant cases for the same
reason that Dave Fischbein Manufacturing Co. and Webb Export Co.
are not helpful--they focus on whether there was manufacturing or
production, not on whether the subject corporation could properly
be considered to be responsible for the manufacturing or
production.

     A recent review of some of the materials in this area does
not deal with the significance of (1) variations in statutory
language and (2) the analysis in Spalding v. Commissioner, 66
T.C. 1017 (1976). Levine et al., “Assessing the Manufacturing
Exception to Subpart F Through Contract Manufacturing
Arrangements”, 1 Taxation of Global Transactions 37 (2001).
                                   - 69 -

C.B. 600, 617; see also Staff of Joint Comm. on Taxation, General

Explanation of the Revenue Provisions of the Tax Equity And

Fiscal Responsibility Act of 1982, 79 n.* (J. Comm. Print 1982)

(hereinafter sometimes referred to as JCT Staff General

Explanation).   The bill as reported by the Senate Finance

Committee and as passed by the Senate included subsection (h), as

proposed to be enacted by section 218(a)(2) of the bill, but did

not have a provision corresponding to paragraph (5)--the

election-out provision.      See text of H.R. 4691 reported by the

Senate Finance Committee, 258-266; text of the Senate-passed

amendments, 263-271.     The election-out provision was added in

conference, and was described in pertinent part as follows in the

Joint Statement of Managers portion of the conference committee

report (H. Conf. Rept. 97-760, 505, 510, 1982-2 C.B. at 617-618,

620; see also JCT Staff General Explanation 85, 87, 92):

     Intangible income

          An election may be made to treat income
     attributable to certain intangible property as income
     of the section 936 corporation eligible for the credit
     (and certain domestic corporations operating in the
     Virgin Islands) under two options--(1) a cost sharing
     rule and (2) a 50/50 profit split. The two exceptions
     with respect to certain types of intangible property
     found in the Senate amendment are deleted. In
     addition, an exception to the Senate bill is made for
     intangible property which has been licensed since prior
     to 1948 to a U.S. corporation operating in a possession
     and is in use by such corporation on the date of
     enactment.

                  *      *     *     *      *   *   *
                                - 70 -

          50/50 split of combined taxable income

     In general

          This election will provide for a split between the
     island affiliate and its U.S. affiliates of the
     combined taxable income of the island affiliate and its
     U.S. affiliates with respect to products produced, in
     whole or in part, in the possession. 50% of such
     profit will be allocated to the island affiliate; 50%
     will be allocated to its U.S. affiliates.

     Significant business presence

          For an island affiliate to be eligible to apply
     the profit split, it must satisfy one of the
     significant business presence tests required for the
     cost sharing election for the product or type of
     service covered by the election. [The first prong.]
     In addition, for products produced in whole or part by
     the island affiliate in the possession, the profit
     split method is available only if the island affiliate
     manufactures or produces the product in the possession
     within the meaning of the controlled foreign
     corporation provisions of the Code (section 954). [The
     second prong.] If the significant business presence
     test (including the controlled foreign corporation
     manufacturing or production rule) is not satisfied for
     a product or type of service within the product area
     covered by the election, no intangibles income
     attributable to that product or type of service will be
     eligible for the credit.

     Respondent’s brief draws our attention to two passages in

the Joint Statement of Managers portion of the conference

committee report, as follows:

     Congressional concerns regarding the potential adverse
     effects of the possessions credit on revenues is reflected
     in the conference report for section 936(h):

          The provision as modified is intended to lessen
          the abuse caused by taxpayers claiming tax-free
          income generated by intangibles developed outside
          of Puerto Rico. The conferees also intend that
          the provision be administered in a fashion so as
          to encourage increased Puerto Rican employment and
                              - 71 -

          investment in depreciable property at as low a
          cost to the Treasury as possible. [Quoting H.
          Conf. Rept. 97-760, at 505 (1982), 1982-2 C.B.
          600, 617.]

               *    *     *     *      *   *    *

          To meet its concerns, Congress incorporated a
     requirement for “real” investment into subsection (h). At
     this point, Congress inserted the requirement at issue that
     in order for a possessions corporation to be eligible to
     elect one of the favorable income allocation methods when
     intangibles were involved, the corporation had to meet the
     significant business presence test. The activities
     necessary to meet this test were to prompt “real and
     significant business activity” [id. at 507, supra, 1982-2
     C.B. at 618-619] in the possessions.

The quoted items appear in the conference committee report; the

quoted language “real and significant business activity” is part

of the following explanation by the conference committee:

     Significant business presence

          For an island affiliate to be eligible to elect cost
     sharing for a product or type of service, it must have and
     maintain a significant business presence in the possession
     with respect to that product or type of service. This test
     is intended to require real and significant business
     activity in the possessions.

          The island affiliate satisfies this requirement with
     respect to a product or type of service if (1) more than 25
     percent of the value added by the affiliated group to the
     product is added by the island affiliate in a possession or
     (2) at least 65 percent of the direct labor costs of the
     affiliated group for the product or service (or in
     connection with the purchase and sale of goods not produced
     by the affiliated group) are incurred by the island
     affiliate and are compensation for services rendered in the
     possession. In general, the figures to be used for these
     calculations will be those used by the island affiliate and
     its affiliates in their required inventory calculations.
     The Secretary may prescribe regulations providing
                               - 72 -

     significant business presence tests for other appropriate
     cases (including a value added test for services), which are
     consistent with the statutory tests.

Id. at 507, supra, 1982-2 C.B. 618-619.

     We are at a loss to understand how the foregoing advances

the thesis of that part of respondent’s brief, that “Attribution

is contrary to the legislative history and the purpose behind the

enactment of section 936.”

     Respondent’s focus on “cost to the Treasury” led us to

examine the revenue estimates for the “Limit on possession

credit” provisions, as they appeared in the Senate Finance

Committee report (S. Rept. 97-494 Vol. 1, 102-103 (1982)), and

the conference committee report (H. Conf. Rept. 97-760, 692-693

(1982)), which are set forth in table 4.15

                               Table 4

                      Estimated increase in revenue
                        (millions of dollars) from:

Fiscal             Senate Finance            Conference
 Year            Committee amendment          agreement

 1983                    412                      201
 1984                  1,027                      428
 1985                  1,251                      473
 1986                  1,356                      516
 1987                  1,470                      559

     The conference committee added paragraph (5), the election-

out provision we deal with in the instant cases, to the Senate



     15
      For a recent example of the use of congressional numerical
estimates as an aid in interpreting legislation, see Toyota Motor
Mfg., Kentucky, Inc. v. Williams, 534 U.S. 184, ___ (2002) (slip
op. at 9).
                                - 73 -

amendment’s new section 936(h), and also modified other parts of

the Senate amendment.    We cannot tell from the public record how

much of the substantial “cost to the Treasury” (i.e., reduction

in the estimated amount of the revenue increase) is attributable

to the election-out change and how much is attributable to the

other changes.    Nevertheless, it is clear that the Congress was

willing to forgo substantial revenue (estimated at almost a

billion dollars for fiscal 1987 alone) as a result of the

determination to modify the provisions of the Senate Amendment.

Under these circumstances, we have no way of knowing (or even

making an educated guess) as to whether the “cost to the

Treasury” phrase in the Joint Statement of Managers was intended

to refer to the election-out provision or any specific other

provision in the revisions relating to the possessions credit.

     Respondent’s other legislative history focus--the statement

that the significant-business-presence test “is intended to

require real and significant business activity in the

possessions”--is in that part of the conference committee’s

explanatory statement that deals with “significant business

presence” for purposes of the cost sharing election--what we have

referred to as the first prong.    As we have pointed out, supra,

respondent has already stipulated away the only challenge that

respondent makes on brief as to whether EAPR has satisfied the

first prong.     Thus, to the extent that the conference committee’s
                              - 74 -

explanatory statement is helpful in explaining the test of the

first prong, in the instant cases EAPR has met that test.

     We conclude that respondent’s legislative history analysis

does not add even a makeweight to respondent’s view of the law.

     However, the legislative history (in this instance,

primarily the sequence of events) does tell us something.    The

Senate amendment does not refer to section 954 in its version of

proposed section 936(h).   The Conference Committee added

paragraph (5) to section 936(h), and specifically made

satisfaction of the second prong depend on “the meaning of

subsection (d)(1)(A) of section 954.”

     As a result, in order to understand how to apply the second

prong, we must examine subsection (d)(1)(A) of section 954.

     b.   Legislative History--Sec. 954(d)

     Enacted by the Revenue Act of 1962, section 954(d) is part

of subpart F of part III of subchapter N of chapter 1.     Through

subpart F, the Congress sought to limit the tax-deferral

abilities of certain foreign corporations--those meeting the

definition of a “controlled foreign corporation”.   Vetco, Inc. v.

Commissioner, 95 T.C. 579, 585-586 (1990).   Under subpart F

(secs. 951 through 964), a U.S. shareholder of a “controlled

foreign corporation” generally must include in gross income a pro

rata share of the corporation’s foreign base company income,
                                 - 75 -

which includes, inter alia, foreign base company sales income.

Section 954(d)(1) provides, in pertinent part, as follows:

     SEC. 954.   FOREIGN BASE COMPANY INCOME.

          (d) Foreign Base Company Sales Income.--

               (1) In general.--For purposes of subsection
          (a)(2), the term “foreign base company sales income”
          means income (whether in the form of profits,
          commissions, fees, or otherwise) derived in connection
          with the purchase of personal property from a related
          person and its sale to any person, the sale of personal
          property to any person on behalf of a related person,
          the purchase of personal property from any person and
          its sale to a related person, or the purchase of
          personal property from any person on behalf of a
          related person where--

                      (A) the property which is purchased (or in
                 the case of property sold on behalf of a related
                 person, the property which is sold) is
                 manufactured, produced, grown, or extracted
                 outside the country under the laws of which the
                 controlled foreign corporation is created or
                 organized, and

                   *    *    *     *      *    *    *

          For purposes of this subsection, personal property does
          not include agricultural commodities which are not
          grown in the United States in commercially marketable
          quantities.

     The language of section 954(d)(1)(A) appeared in almost

identical form as proposed new Code section 952(e)(2)(A) in H.R.

10650 (bill pp. 112-113), the Revenue Act of 1962, as reported by

the House Ways and Means Committee.       The enacted language

appeared in identical form as proposed new Code section

954(d)(1)(A) in H.R. 10650 (bill p. 190), as reported by the

Senate Finance Committee.   H. Conf. Rept. 87-2508 (1962), 6-7
                              - 76 -

(statutory language), 31 (description), 1962-3 C.B. 1129, 1159.

The committee reports explain as follows:

          The “foreign base company sales income” referred to
     here means income from the purchase and sale of property,
     without any appreciable value being added to the product by
     the selling corporation. This does not, for example,
     include cases where any significant amount of manufacturing,
     major assembling, or construction activity is carried on
     with respect to the product by the selling corporation. On
     the other hand, activity such as minor assembling,
     packaging, repackaging or labeling will not be sufficient to
     exclude the profits from this definition.

          The sales income with which your committee is primarily
     concerned is income of a selling subsidiary (whether acting
     as principal or agent) which has been separated from
     manufacturing activities of a related corporation merely to
     obtain a lower rate of tax for the sales income. This
     accounts for the fact that this provision is restricted to
     sales of property, to a related person, or to purchases of
     property from a related person. Moreover, the fact that a
     lower rate for tax for such a company is likely to be
     obtained only through purchases and sales outside of the
     country in which it is incorporated, accounts for the fact
     that the provision is made inapplicable to the extent the
     property is manufactured, produced, grown, or extracted in
     the country where the corporation is organized or where it
     is sold for use, consumption, or disposition in that
     country. Mere passage of title or the place of the sale are
     not relevant in this connection.

              *     *     *     *      *    *     *

          (d) Foreign base company sales income.--Paragraph (1)
     of subsection (d) corresponds to section 952(e)(2) of the
     bill as passed by the House and defines foreign base company
     sales income as income (whether in the form of profits,
     commissions, fees, or otherwise) derived in connection with:

               (1) the purchase of personal property from a
          related person and its sale to any person,

               (2) the sale of personal property to any person on
          behalf of a related person,
                              - 77 -

                (3) the purchase of personal property from any
           person and its sale to a related person, or

                (4) the purchase of personal property from any
           person on behalf of a related person,

     where (A) the property which is purchased (or in the case of
     property sold on behalf of a related person, the property
     which is sold) is manufactured, produced, grown, or
     extracted outside the country under the laws of which the
     controlled foreign corporation is created or organized, and
     (B) the property is sold for use, consumption, or
     disposition outside such foreign country, or, in the case of
     property purchased on behalf of a related person, is
     purchased for use, consumption, or disposition outside such
     foreign country.

          The definition does not apply to income of a controlled
     foreign corporation from the sale of a product which it
     manufactures. In a case in which a controlled foreign
     corporation purchases parts or materials which it then
     transforms or incorporates into a final product, income from
     the sale of the final product would not be foreign base
     company sales income if the corporation substantially
     transforms the parts or materials, so that, in effect, the
     final product is not the property purchased. Manufacturing
     and construction activities (and production, processing, or
     assembling activities which are substantial in nature) would
     generally involve substantial transformation of purchased
     parts or materials. [S.Rept. 87-1881, 84, 245 (1962), 1962-
     3 C.B. 703, 790, 949; H. Rept. 87-1447, 62, A94-A95 (1962),
     1962-3 C.B. 402, 466, 592-593.]

     In general, taxpayers found it beneficial under subpart F to

show that income of a controlled foreign corporation was derived

from the sale of personal property which was manufactured or

produced in a foreign country by the controlled foreign

corporation.

     c.   Harmonizing; Conclusions

     In the instant cases each side contends that Treasury

Regulations require a decision favoring that side.   Respondent
                                - 78 -

urges us to rely on section 1.936-5(b)(6), Q&A-1, Income Tax

Regs.16   Petitioners urge us to rely on section 1.954-3(a)(4),




     16
      Sec. 1.936-5(b)(6), Q&A-1, Income Tax Regs., provides as
follows:

     Sec. 1.936-5 Intangible property income when an election
          out is made: Product, business presence, and contract
          manufacturing.

                  *    *    *     *      *   *   *

           (b) Requirement of significant business presence--

                  *    *    *     *      *   *   *

          (6) Manufacturing within the meaning of section
     954(d)(1)(A).
          Q. 1: What is the test for determining, within the
     meaning of section 954(d)(1)(A), whether a product is
     manufactured or produced by a possessions corporation in a
     possession?
          A. 1: A product is considered to have been
     manufactured or produced by a possessions corporation in a
     possession within the meaning of section 954(d)(1)(A) and
     sec. 1.954-3(a)(4) if--
          (i)    The property has been substantially transformed
     by the possessions corporation in the possession;
          (ii) The operations conducted by the possessions
     corporation in the possession in connection with the
     property are substantial in nature and are generally
     considered to constitute the manufacture or production of
     property; or
          (iii) The conversion costs sustained by the possessions
     corporation in the possession, including direct labor,
     factory burden, testing of components before incorporation
     into an end product and testing of the manufactured product
     before sales account for 20 percent or more of the total
     cost of goods sold of the possessions corporation.

     In no event, however, will packaging, repackaging, labeling,
     or minor assembly operations constitute manufacture or
     production of property. See particularly examples 2 and 3
     of sec. 1.954-3(a)(4)(iii).
                               - 79 -

Income Tax Regs.17   Respondent responds that--


    17
      Sec. 1.954-3(a)(4), Income Tax Regs., provides as follows
(examples omitted):

    Sec. 1.954-3 Foreign base company sales income.

         (a) Income included.

                *     *    *     *      *   *     *

         (4) Property manufactured or produced by the controlled
    foreign corporation--(i) In general. Foreign base company
    sales income does not include income of a controlled foreign
    corporation derived in connection with the sale of personal
    property manufactured, produced, or constructed by such
    corporation in whole or in part from personal property which
    it has purchased. A foreign corporation will be considered,
    for purposes of this subparagraph, to have manufactured,
    produced, or constructed personal property which it sells if
    the property sold is in effect not the property which it
    purchased. In the case of the manufacture, production, or
    construction of personal property, the property sold will be
    considered, for purposes of this subparagraph, as not being
    the property which is purchased if the provisions of
    subdivision (ii) or (iii) of this subparagraph are
    satisfied. For rules of apportionment in determining
    foreign base company sales income derived from the sale of
    personal property purchased and used as a component part of
    property which is not manufactured, produced, or
    constructed, see subparagraph (5) of this paragraph.
         (ii) Substantial transformation of property. If
    purchased personal property is substantially transformed
    prior to sale, the property sold will be treated as having
    been manufactured, produced, or constructed by the selling
    corporation. The application of this subdivision may be
    illustrated by the following examples:

                *     *    *     *      *   *     *

         (iii) Manufacture of a product when purchased
    components constitute part of the property sold. If
    purchased property is used as a component part of personal
    property which is sold, the sale of the property will be
    treated as the sale of a manufactured product, rather than
    the sale of component parts, if the operations conducted by
                                                  (continued...)
                              - 80 -

     Petitioners’ primary authority should be the regulation that
     explicates the section of the Internal Revenue Code that is
     at issue in this case [i.e., sec. 936, which provides the
     credit that is the subject of the dispute], particularly
     where this regulation addresses the issue that is in
     dispute.

Petitioners point out that the Congress made the choice of

requiring that the section 936(h)(5)(B)(ii) second prong test be

determined “within the meaning of section 954(d)(1)(A)”, and

“Accordingly, the determination of whether EAPR manufactured or

produced the video games must be made pursuant to section

954(d)(1)(A) (and the regulations and other authority

thereunder), and not pursuant to any other principles.”

     Section 936(h)(5)(B)(ii) and the legislative history of its

enactment in TEFRA 82 make it clear that the test for satisfying

the second prong is to be that which is derived from section

954(d)(1)(A).   In this, we agree with petitioners.   We reject



     17
      (...continued)
     the selling corporation in connection with the property
     purchased and sold are substantial in nature and are
     generally considered to constitute the manufacture,
     production, or construction of property. Without limiting
     this substantive test, which is dependent on the facts and
     circumstances of each case, the operations of the selling
     corporation in connection with the use of the purchased
     property as a component part of the personal property which
     is sold will be considered to constitute the manufacture of
     a product if in connection with such property conversion
     costs (direct labor and factory burden) of such corporation
     account for 20 percent or more of the total cost of goods
     sold. In no event, however, will packaging, repackaging,
     labeling, or minor assembly operations constitute the
     manufacture, production, or construction of property for
     purposes of section 954(d)(1). * * *
                              - 81 -

respondent’s thesis, that regulations under section 936 must

control because the credit that petitioners claim is a credit

under section 936.   However, we are not aware of, and petitioners

have not directed our attention to, any requirement that a

regulation cannot effectively control a determination under

section 954 unless it is a regulation under section 954.    Section

7805(a), the basic regulation-prescribing authority for the

Treasury Department does not impose such a restriction.

Accordingly, we reject petitioners’ thesis, that we follow

regulations numbered 1.954 and ignore regulations numbered 1.936.

Instead, we conclude that both section 1.936-5(b)(6), Q&A-1,

Income Tax Regs., and section 1.954-3(a)(4), Income Tax Regs.,

are authoritative interpretations of the statute and guide us in

the instant cases in ruling on EAPR’s eligibility to use the

profit split method of section 936(h)(5)(C)(ii), by determining

whether or not the video games were manufactured or produced in

Puerto Rico by EAPR “within the meaning of (d)(1)(A) of section

954.”   To the extent possible, we should harmonize the foregoing

regulations.   See, e.g., Bencivenga v. Western Pa. Teamsters, 763

F.2d 574, 579 (3d Cir. 1985), where the Court of Appeals

“conclude[d] that in this instance the language of [Treasury]

Regulation 1.411(d)-3(b) is not in fact inconsistent with

Regulation 1.411(a)-7(a)(1)(ii).”   We reach the same conclusion

with regard to the regulations before us.
                                - 82 -

     Section 1.954-3(a)(4)(i), Income Tax Regs., provides the

following basic general rule:

          Foreign base company sales income does not include
     income of a controlled foreign corporation derived in
     connection with the sale of personal property manufactured,
     produced, or constructed by such corporation in whole or in
     part from personal property which it has purchased.
     [Emphasis added.]

The remaining language in subparagraph (4) expands on this basic

general rule.   Petitioners’ focus on the text of these expansions

ignores the context provided by the general rule, that the

property must have been manufactured or produced by the

corporation that is the subject of the inquiry.

     Section 1.936-5(b)(6), Q&A-1, Income Tax Regs., requires in

each of its alternatives, that the activity be performed “by the

possessions corporation”.   Respondent’s focus on this phrase

ignores the fact that corporations pay persons (individuals or

other entities) to actually do things, and that the regulation

does not tell us whether we are to take into account for these

purposes only those things done by employees or officers of the

corporation that is the subject of the inquiry.

     Neither of the foregoing regulations explicitly allows or

disallows “attribution”, even though both of these regulations

require that the corporation being tested be the manufacturer or

the producer.   Thus, both regulations present the same question

of interpretation in almost the same words.   In this respect, the
                             - 83 -

two regulations are consistent with each other, and neither

regulation clearly answers the question we face.

     “Plain meaning” contentions notwithstanding, we cannot

properly lay the findings of fact next to the statute or

regulations and just read off the answers to the questions here

presented.18

     Given that petitioners failed to consider the “by such

corporation” language of section 1.954-3(a)(4)(i), Income Tax

Regs., and that respondent failed to consider the reality that a

corporation engages others to do things on its behalf, we cannot

conclude with the requisite degree of certainty that the factual

record presented herein is sufficient.   The shortcomings of the

parties’ legal contentions noted above make it far from clear

that all of the material facts have even been presented, let

alone that there is not a genuine issue with respect thereto.

Accordingly, even though we cannot agree with respondent’s

analysis, we conclude that petitioners have failed to carry their

obligation as movants to show that there is no substantial



     18
      See, e.g., the following description of a court’s role in
certain “simple” litigation:

     When an act of Congress is appropriately challenged in the
     courts as not conforming to the constitutional mandate the
     judicial branch of the Government has only one duty,--to lay
     the article of the Constitution which is invoked beside the
     statute which is challenged and to decide whether the latter
     squares with the former. * * * [United States v. Butler, 297
     U.S. 1, 62 (1936).]
                               - 84 -

dispute about a material fact and that they are entitled to

judgment as a matter of law.   See Anderson v. Liberty Lobby,

Inc., 477 U.S. 242, 255 (1986) (citing Kennedy v. Silas Mason

Co., 334 U.S. 249 (1948)).

5.   Holding

     We hold for respondent on the second prong--that

petitioners’ motion for partial summary judgment will not be

granted as to whether EAPR’s activities with respect to the video

games in the years before the Court amount to EAPR’s manufacture

or production of video games in Puerto Rico within the meaning of

subsection (d)(1)(A) of section 954.    We hold for petitioners on

the first prong--that petitioners’ motion for partial summary

judgment will be granted as to whether EAPR’s activities with

respect to the video games in the years before the Court amount

to EAPR’s having a substantial business presence in Puerto Rico

within the meaning of clause (ii) of section 936(h)(5)(B) without

taking into account the requirements of the final flush language

of that clause.



                                          An appropriate order will

                                    be issued granting in part and

                                    denying in part petitioners’

                                    motion for partial summary

                                    judgment.
