Rev. Rul. 84-19

1984-1 C.B. 179, 1984-6 I.R.B. 6.

                       Internal Revenue Service
                                 Revenue Ruling

       COST OF LIVING ALLOWANCES;  DIFFERENTIALS;  GOVERNMENT EMPLOYEES;
                               REPUBLIC OF PANAMA

                          Published: February 6, 1984

SECTION 912. - -EXEMPTION FOR CERTAIN ALLOWANCES, 26 CFR 1.912-1: Exclusion of certain cost of living allowances

  Cost of living allowances;  differentials;  government employees;  Republic of Panama.  The overseas tropical differential (OTD) paid to civilian employees of a United States government agency living and working in the Republic of Panama is not excludable from the gross income of such employees under section 912 of the Code.

ISSUE

  Whether the overseas (tropical) differential, paid pursuant to 35 C.F.R. section 253.135 (1979) by an agency of the United States Government to its civilian employees living and working in the Republic of Panama, is excludable from the gross income of such employees under section 912 of the Internal Revenue Code.

FACTS

  Taxpayers are United States citizens who are civilian employees of a United States government agency.  During the tax year 1979, taxpayers were paid an overseas (tropical) differential (OTD) pursuant to 35 C.F.R. section 253.135 (superseded by 35 C.F.R. sections 251.31 and 251.32 (1982)) while working at their permanent duty station in the Republic of Panama in an area formerly known as the Panama Canal Zone.  The OTD is limited to 25 percent of the basic pay of employees entitled to receive it and is not based on any comparison between the cost of living in the District of Columbia and the Republic of Panama.

LAW AND ANALYSIS

  Section 61(a) of the Code and section 1.61-1(a) of the Income Tax Regulations provide, in part, that, except as otherwise provided by law, gross income means all income from whatever source derived.

  Section 912(1)(C) of the Code provides that amounts received by civilian officers and employees of the United States government as allowances or otherwise (but not amounts received as post-differentials) under Title II of the Overseas Differentials and Allowances Act (ODA), P.L. 86-707, 74 Stat. 793 (1960), shall not be included in gross income and shall be exempt from taxation.

  Section 912(2) of the Code provides, in part, that amounts (other than amounts received under Title II of the ODA) received as cost-of-living allowances by civilian officers or employees of the Government of the United States stationed outside the continental United States shall not be included in gross income and shall be exempt from taxation.

  Section 1217(a) of the Panama Canal Act of 1979 (PCA), P.L. 96-70, 93 Stat. 452 (1979) provides, in part, that additional compensation may be paid as an overseas recruitment or retention differential to any individual who (1) before October 1, 1979 was employed by an agency in the area then known as the Canal Zone, or (2) is an employee who was recruited on or after October 1, 1979, for placement in the Republic of Panama;  provided that, in the judgment of the head of the agency concerned, the recruitment or retention of the individual is essential.

  Section 1217(d) of the PCA expressly provides that Subchapter III of Chapter 59 of Title V of the ODA shall not apply with respect to any employee whose permanent duty station is in the Republic of Panama and who is employed by a United States Government agency. Subchapter III of Chapter 59 of Title V of the ODA includes all of Title II of the ODA.  Therefore, Title II of the ODA does not apply to civilian employees of the United States Government whose permanent duty station is in the Republic of Panama.  Further, Title II of the ODA has never applied to civilian employees or the United States Government working in the former Panama Canal Zone because such Zone was not a foreign area with respect to which Title II of the ODA applied.

  Since OTD payments in the present case are not now, nor have they ever been, Title II ODA differentials or allowances, section 912(1)(C) is not applicable to exclude such OTD payments from gross income.

  Section 4.02 of Rev. Rul. 59-407, 1959-2 C.B. 19, provides, in general, that a cost-of-living allowance within the meaning of section 912(1) of the Code (now section 912(2)) is an allowance based on living costs substantially higher than the cost-of-living in the District of Columbia and granted to enable employees to render more complete and efficient service in carrying out their official assignments.  Section 4.05 of Rev. Rul. 59-407 provides, in part, that allowances granted by reason of conditions of environment that differ substantially from conditions of environment in the United States and that warrant additional compensation as a recruitment incentive are clearly distinguishable from cost-of-living allowances.  Section 4.05 concludes that allowances or differentials granted because of conditions of environment are compensatory in nature and are includable in gross income.

  In the present case, the OTD paid to Government civilian employees is limited to 25 percent of their basic pay and is not

dependent on any cost of living comparison.  In addition, the OTD was intended to provide a compensatory recruitment and retention incentive so that United States Government agencies would not have difficulty recruiting and retaining United States civilian employees with skills that are critical to continue effective operation of the Panama Canal and essential support activities.  H.R.Rep. No. 98 (Part I), 96th Cong., 1st Sess. 54-55 (1979).  Therefore, the OTD is not a cost-of-living allowance within the meaning of section 912(2) of the Code.

HOLDING

  The overseas (tropical) differential (OTD) paid to civilian employes of a United States Government agency living and working in the Republic of Panama is not excludable from the gross income of such employees under section 912 of the Code.