During each of its taxable years ended October 31, 1997, through October 31, 2001, Deere & Co. received income from operations conducted through unincorporated branches in Germany, Italy, and Switzerland. In calculating the consolidated tax in its 2001 tax return, Deere claimed a credit of $5,978,898 based on Section 41 of the Internal Revenue Code. The section relates to credits premised on the taxpayer's research and development expenditures.

In calculating the credit, Deere elected the "alternative incremental research credit" prescribed by Section 41(c)(4). For the four-year period preceding 2001, the company calculated its average annual gross receipts to be $11,737,809,783.¹ In determining the total and average annual gross receipts, Deere reduced the total income by gross receipts, less returns and allowances, and other income from the operations of its foreign branches.

However, the Internal Revenue Service disagreed with this approach. The service determined that Deere's average annual gross receipts for the four taxable years was $13,373,420,885. Last October the Tax Court agreed with the IRS (see Deere & Co. and Consolidated Subsidiaries v. Commissioner, 133 T.C. No. 11 (2009)).

Section 41(a) provides that, for purposes of the code's general business credit rule (Section 38), the research credit for the taxable year is an amount equal to the sum of (1) 20% of the excess of the taxpayer's qualified research expenses for the taxable year, over the base amount, and (2) 20% of the taxpayer's basic research payments.

Under Section 41(c)(1), the "base amount" is defined as the "fixed base percentage" multiplied by the average annual gross receipts for the four taxable years preceding the taxable year. In general, the fixed-base percentage is the percentage that expenses are of receipts. More specifically, in the Deere case it is the percentage that the aggregate qualified research expenses — for taxable years beginning after 1983 and before 1989 — are of the aggregate gross receipts for those taxable years (but not more than 16%).

Section 41(c)(4), enacted by Congress in 1996, allows a taxpayer to elect an alternative method of computing the credit. Deere made the election, and under the alternative method, the credit is the sum of:

• 2.65% of the qualified research expenses for the taxable year that exceed 1% of the average annual gross receipts for the four taxable years preceding the credit year, but do not exceed 1.5% of that average;
• 3.2% of the qualified research expenses for the taxable year that exceed 1.5% of the average annual gross receipts for the four taxable years preceding the credit year, but do not exceed 2% of that average; and
• 3.75% of those expenses that exceed 2% of that average.

In addition, Section 41(c)(6) provides that gross receipts for any taxable year will be reduced by returns and allowances during that year. In the case of a foreign corporation, only gross receipts that are "effectively connected" with the conduct of a trade or business within the United States, Puerto Rico, or any possession of the United States are taken into account.

Foreign Branches Are Different
Deere argued that the "structure of the statute" demonstrates that Congress did not intend for a company to include the total annual gross receipts of its foreign branches in calculating average annual gross receipts. Its reasoning was as follows: because Section 41 does not provide a comprehensive definition of gross receipts, no negative implication should be drawn from the absence of an express exclusion in the case of an unincorporated foreign branch. Instead, because the credit is calculated for all commonly controlled corporations and unincorporated trades or businesses, it follows that gross receipts from a foreign branch operation should be excluded, just as the statute expressly does for a foreign corporation. The court did not embrace this logic.

The court noted that if Congress had wanted to exclude from, or include, the gross receipts in the calculation on the basis of principles similar to the ones lawmakers used in the second sentence of Section 41(c)(6), it knew how to so mandate and would have so mandated. It did not so mandate and its silence is "strident," added the court.

Deere then turned its attention to the legislative history of the second sentence of
Section 41(c)(6). That history, on which Deere relied, refers to a foreign affiliate (rather than a foreign corporation). The court held that Deere's reliance on this legislative history was "misplaced." The court observed that the second sentence of Section 41(c)(6) is clear and unambiguous on its face and applies only in the case of a foreign corporation. We may not, the court said, resort to legislative history to give meaning to an unambiguous statute. The clear language of the second sentence of Section 41(c)(6) is, in the court's view, controlling.

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