II. Discussion A. Section 936 and Section 1.936–6(b)(1), Q&A-1 & Under the statutory scheme of section 936, a U.S. corporation, such as CRI, which elects the application of section 936 and meets certain requirements with respect to operating in a possession, is entitled to a credit against the U.S. tax on certain possession-related income. Section 936 provides the following: SEC. 936(a). ALLOWANCE OF CREDIT. (1) IN GENERAL.— * * * if a domestic corporation elects the application of this section *** there shall be allowed as a credit against the tax imposed by this chapter 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. * * * * * * (d) DEFINITIONS AND SPECIAL RULES.-For purposes of this section (2) QUALIFIED POSSESSION SOURCE INVESTMENT INCOME.-The term "qualified possession source investment income" means gross income which (A) is from sources within a possession of the United States in which a trade or business is actively conducted, and (B) the taxpayer establishes to the satisfaction of the Secretary is attributable to the investment in such possession (for use therein) of funds derived from the active conduct of a trade or business in such possession, or from such investment, less the deductions properly apportioned or allocated thereto. [Emphasis added.] Section 936(h) provides the following: SEC. 936(h). Tax Treatment of Intangible Property Income.— * * * (3) INTANGIBLE PROPERTY INCOME.-For purposes of this subsection(A) IN GENERAL.-The term "intangible property income" means the gross income of a corporation attributable to any intangible property * * * (B) INTANGIBLE PROPERTY.-The term "intangible property" means any (i) patent, invention, formula, process, design, pattern, or knowhow; (v) method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; *** which has substantial value independent of the services of any individual. * (5) ELECTION OUT. * * * * * * * (C) Methods of computation of taxable income.-If an election of one of the following methods is in effect pursuant to subparagraph (F) with respect to a product or type of service, an electing corporation shall compute its income derived from the active conduct of a trade or business in a possession with respect to such product or type of service in accordance with the method which is elected. * (ii) Profit split.— (I) GENERAL RULE.-If an election of this method is in effect, the electing corporation's taxable income derived from the active conduct of a trade or business in a possession with respect to units of a product produced * * *, in whole or in part, by the electing corporation shall be equal to 50 percent of the combined taxable income of the affiliated group (other than foreign affiliates) derived from covered sales of units of the product produced * * *, in whole or in part, by the electing corporation in a possession. (II) Computation of combined taxable income.-Combined taxable income shall be computed separately for each product produced ***, in whole or in part, by the electing corporation in a possession. Combined taxable income shall be computed (notwithstanding any provision to the contrary) for each such product *** by deducting from the gross income of the affiliated group (other than foreign affiliates) derived from covered sales of such product * * * all expenses, losses, and other deductions properly apportioned or allocated to gross income from such sales *** and a ratable part of all expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income, which are incurred by the affiliated group (other than foreign affiliates). * * * (7) REGULATIONS.-The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection *** [Emphasis added.] In the simplest terms, section 936(a) allows for a tax credit. The amount of this credit is equal to the portion of tax attributable to the "taxable income" derived from conducting business in a possession. Section 936(h) determines the treatment of intangible property income. Intangible property is broadly defined in section 936(h) and includes, of relevance here, formulas, processes, trademarks, trade names, brand names, franchises, licenses and contracts, methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, customer lists, and technical data. Sec. 936(h)(3)(B)(i), (iii), (iv), (v). The formula for beverage bases or concentrates for various soft drinks and syrups is considered intangible property under section 936(h)(3)(B). See also sec. 1.936-5(a), A-6, Example (1)(A), Income Tax Regs. In the absence of an election under section 936(h)(5), intangible property income is taxed to the U.S. shareholders of the possessions corporation. If a possessions corporation makes a valid election, its active trade or business income with respect to the product for which the election is made is computed in accordance with the method elected. CRI elected the "profit-split" method under section 936(h)(5)(C)(ii). Under the profit-split method, the taxable income of the "electing corporation", with respect to a product produced in a possession, is deemed to be 50 percent of the "combined taxable income" of the "affiliated group" derived from sales of the product to nonaffiliates or to foreign affiliates.3 The remaining 50 percent of the combined taxable income is allocated to, and treated as, the taxable income of the appropriate U.S. affiliate or affiliates. Sec. 936(h)(5)(C)(ii)(I), (III). Combined taxable income equals the gross income of the section 936 corporation and its U.S. affiliates derived from sales of the possession product to nonaffiliates or foreign affiliates less the expenses of the section 936 corporation and the U.S. 3 The term "electing corporation" means a domestic corporation for which an election under sec. 936 is in effect. Sec. 936(h)(5)(E). The term "affiliated group" means the electing corporation and all other organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interest, within the meaning of sec. 482. Sec. 936(h)(5)(C)(i)(I)(b). affiliates allocated and apportioned to such gross income. Sec. 936(h)(5)(C)(ii)(II). Thus, the section 936 credit equals the tax attributable to 50 percent of the combined taxable income figure. Congress recognized in enacting section 936(h) that some section 936 corporations produce products that are not sold as such to unrelated parties but rather are transferred to affiliates and used as component parts in the production of other products that are then sold by the affiliates to unrelated parties. Congress directed the Secretary of the Treasury to write the rules with respect to such component products. Section 936(h)(7) requires the Secretary to prescribe such regulations as may be necessary and appropriate to carry out the purposes of section 936(h). Section 1.936-6, Income Tax Regs., provides the following: (b) Profit split option-(1) Computation of combined taxable income. Question 1: In determining combined taxable income from sales of a possession product, how are the allocations and apportionments of expenses, losses, and other deductions to be determined? Answer 1: (i) Expenses, losses, and other deductions are to be allocated and apportioned on a "fully-loaded" basis under § 1.861-8 to the combined gross income of the possessions corporation and other members of the affiliated group * * * The amount of research, development, and experimental expenses allocated and apportioned to combined gross income is to be determined under § 1.861-8(e)(3). * * * Other expenses which are subject to § 1.861-8(e) are to be allocated and apportioned in accordance with that section. For example, interest expense * * * is to be allocated and apportioned under § 1.861–8(e)(2). With the exception of marketing and distribution expenses discussed below, the other remaining expenses which are definitely related to a class of gross income shall be allocated to that class of gross income and shall be apportioned on the basis of any reasonable method, as described in § 1.861-8(b)(3) and (c)(1). Examples of such methods may include, but are not limited to, those specified in § 1.861-8(c)(1)(i) through (vi). Question 12: If the possession product is a component product or an endproduct form, how is the combined taxable income for such product to be determined? Answer 12: (i) In computing combined taxable income, the sales price of the component product *** is determined as follows. With respect to a component product, an independent sales price from comparable uncontrolled transactions must be used if such price can be determined in accordance with sec. 1.482-2(e)(2). If an independent sales price of the component product from comparable uncontrolled transactions cannot be determined, then the possessions corporation must treat the sales price for the component product as equal to the same proportion of the third party sales price of the integrated product which the production costs attributable to the component product bear to the total production costs for the integrated product. * * * (ii) *** The possessions corporation will determine its costs * * * attributable to the possession product and its expenses allocable and apportionable to the possession product under sec. 1.861-8, as described in question and answer 1 * * * Each member of the affiliated group that is a United States person, other than the possessions corporation, shall determine its costs (other than costs incurred for materials purchased from a U.S. affiliate) attributable to the possession product, and its expenses allocable and apportionable to the integrated product under sec. 1.861-8, as described in question and answer 1 of this paragraph (b)(1). Each such United States person (other than the possessions corporation) shall apportion to the possession product, on the basis of the ratio of the production costs for the possession product to the total production costs for the integrated product, the expenses that such affiliate allocated and apportioned to the integrated product. * * * [Emphasis added.] erns For purposes of computing combined taxable income, section 1.936-6(b)(1), Q&A-1, Income Tax Regs. (Q&A-1), govthe computation of combined taxable income by prescribing rules for the allocation and apportionment of expenses derived from the sale of a possession product sold to unrelated third parties in unchanged form. Q&A-12, on the other hand, appears to govern the computation of combined taxable income by prescribing rules for the allocation and apportionment of expenses derived from the sale of a product sold to unrelated third parties which contains a component possession product. B. Parties' Positions Respondent first argues that Q&A-1 governs in the instant case, requiring that all expenses USA incurs and those CBO expenses that are factually related to gross income from the sale of concentrate be apportioned in full to such income regardless of the form in which the possession product is sold. Second, respondent argues in the alternative that even were Q&A-12 controlling in the instant case, the application of the production cost ratio contained in Q&A-12 produces absurd results, and petitioner's motion should be denied on the basis of Exxon Corp. v. Commissioner, 102 T.C. 721 (1994). Respondent maintains that the question before this |