# PPG Industries, Inc. v. Commissioner

> United States Tax Court · December 31, 1970 · 29 T.C.M. 1710

URL: https://www.frixlaw.com/law-library/cases/4624802

## Case

- **Full name:** PPG Industries, Inc. v. Commissioner.
- **Court:** United States Tax Court
- **Decided:** December 31, 1970
- **Citations:** 29 T.C.M. 1710; 1970 T.C. Memo. 354; 1970 Tax Ct. Memo LEXIS 1
- **Precedential status:** Unpublished
- **Opinion:** Opinion
- **Cited by:** 0 later opinions in the Frix Law Library

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## Opinion text

PPG Industries, Inc. v. Commissioner.
PPG Industries, Inc. v. Commissioner
Docket No. 5842-66.
United States Tax Court
T.C. Memo 1970-354 ; 1970 Tax Ct. Memo LEXIS 1 ; 29 T.C.M. (CCH) 1710 ; T.C.M. (RIA) 70354 ;
December 31, 1970 , Filed
Ira T. Wender , Peter L. Briger , Carl E. Glock, Jr. , Charles R. Pascoe and Kenneth P. Simon, for the petitioner. Donald W. Howser and Gary L. Stansbery , for the respondent.
MULRONEY
Memorandum Findings of Fact and Opinion
MULRONEY, *3 Judge: This case involves income tax deficiencies determined by respondent for the years 1960 and 1961 in the respective amounts of $2,811,000.86 and $2,684,387.67 and additional deficiencies in income tax claimed by respondent by amendments to his answer in the amounts of $300,564 and $324,194 for the years 1960 and 1961, respectively. Concessions involving several issues have been made by both parties.
The remaining issues before this Court are (1) whether respondent correctly allocated income in 1960 and 1961 to petitioner from Pittsburgh Plate Glass International S.A. (petitioner's wholly-owned Swiss subsidiary) in 1960 and 1961 under section 482 of the 1954 Internal Revenue Code ; (2) whether gains realized by petitioner in 1960 and 1961 from the transfer by petitioner to Pittsburgh Plate Glass International S.A. of patents and technology are taxable as capital gains or as ordinary income; (3) whether the transfer of certain stock by petitioner's Brazilian subsidiary to Pittsburgh Plate Glass International S.A. in 1961 resulted in a constructive dividend to petitioner in the amount of $455,959; (4) whether respondent correctly allocated income in the amount of $27,304 in 1960 *4 to petitioner from its Brazilian subsidiary under section 482 of the 1954 Internal Revenue Code as a result of an interest-free loan made by petitioner to the subsidiary; and (5) whether the transfer of certain assets in 1960 by Distribuidora Quimica S.A. (an Argentine corporation which was a second-tier subsidiary of petitioner) to Pittsburgh Plate Glass Argentina, S.A. resulted in a constructive dividend to petitioner.
Findings of Fact
PPG Industries, Inc. (hereinafter called petitioner), a manufacturer of glass, fiber glass and paint products, was incorporated under the laws of Pennsylvania in 1883. Its principal office and place of business at the time the petition in this case was 1711 filed was Pittsburgh, Pennsylvania. Petitioner filed its Federal tax returns for the years here involved with the district director of internal revenue at Pittsburgh, Pennsylvania. At all times here relevant petitioner kept its books and prepared its Federal income tax returns on a calendar year basis and on an accrual method of accounting.
Petitioner is successor in interest to Columbia-Southern Chemical Corporation (hereinafter called Columbia-Southern), a wholly-owned subsidiary that *5 was merged into petitioner on December 31, 1960.
Petitioner's operating divisions during the years here involved included a glass division, a chemical division, a paint and brush division, and a fiber glass division.
After World War II there was a great shortage of glass in the United States. In the years 1955 and 1956 petitioner bought more glass from foreign suppliers than it sold to foreign customers. In 1957 petitioner's productive facilities caught up with demand. Prior to 1957, petitioner's physical facilities and the domestic demand for glass limited the amount of glass products it could export.
Prior to 1958 petitioner had investments in approximately 37 foreign corporations. Among these the principal operating companies in which petitioner had a controlling interest were Duplate Canada, Limited, a Canadian corporation hereinafter called Duplate (glass), Canadian Pittsburgh Industries, Ltd., a Canadian corporation hereinafter called CPI (glass), Societe Anonyme des Glaces de Courcelles, a Belgian corporation hereinafter called Courcelles (glass) and Standard Chemical Limited, a Canadian corporation hereinafter called Standard Chemical. Petitioner's foreign investments *6 included a minority interest in Cristalerias de Chile, S.A., a Chilean corporation (glass), Cia Comercial de Vidros do Brasil, a Brazilian corporation hereinafter called CVB (glass), Cia Anonima Industrias Miller de Venezuela, a Venezuelan corporation hereinafter called Miller de Venezuela (glass), Cristalerias Rigolleau, S.A., an Argentine corporation (glass), Cia Vidraria Santa Marina, a Brazilian corporation hereinafter called Santa Marina (glass), Industrias Reunidas Vidrobras Limitada, a Brazilian corporation hereinafter called Vidrobras (paint), Pinturas Pittsburgh de Mexico, S.A., a Mexican corporation hereinafter called Pinturas Pittsburgh (paint) and Pinturas Tucan, S.A., a Venezuelan corporation hereinafter called Pinturas Tucan (paint).
Prior to 1958 petitioner had been relatively inactive in licensing foreign rights to its technology and in expanding manufacturing activities abroad.
For at least 30 years prior to 1958 petitioner had an export department to handle its export sales of glass, paint and fiber glass products outside the Western Hemisphere. The export department did not handle chemical sales.
Prior to 1959 petitioner operated a Western Hemisphere trade *7 corporation, Pittsburgh Plate Glass Export Corporation (hereinafter called PPGE) which was organized in 1955. For all practical purposes PPGE was integrated with the export department. Petitioner's export chemical sales in the Western Hemisphere were included among the products handled by PPGE. Columbia-Southern did not actively seek export markets for its chemical products. Generally, it accepted orders only when approached by foreign customers.
Petitioner's export department and PPGE handled the sales of petitioner's products to Duplate and CPI as well as other export sales. They made most of the non-Canadian export sales through commission agents and distributors located abroad. The export department accepted orders from customers, placed orders with the factories, expedited the orders, helped customers with their problems and handled export documentations.
Petitioner established the prices for export sales handled by PPGE as well as by petitioner's export department. The export department usually sold petitioner's products, particularly glass products, at prices that yielded a higher profit than on domestic sales. These higher prices tended to restrict export sales. The export *8 department could not on its own initiative grant special allowances and discounts. Export department personnel were not free to travel in order to develop new, or maintain existing export markets without the specific approval of petitioner's executive vice president. The export department did not have personnel skilled in financing export sales but depended upon petitioner's treasurer for guidance in credit matters.
In 1958, and for some years prior to that, Leland Hazard (who in 1958 was general counsel, vice president and a director of the petitioner) was aware of the 1712 opportunities for American capital and American skills in the European markets. Hazard, who was influential in the formation of Pittsburgh Plate Glass International, S.A., had for years endeavored to have petitioner for an international subsidiary.
Pittsburgh Plate Glass International S.A. (hereinafter called PPGI) was incorporated under the laws of Switzerland in July 1958 as a wholly-owned subsidiary of petitioner. The decision to form PPGI was made by petitioner's board of directors on April 1, 1958. The controlling purposes behind petitioner's decision to organize PPGI as its international subsidiary *9 were (1) to expand the sale of petitioner's products outside the United States, (2) to develop opportunities outside the United States for the exploitation of petitioner's technology, and (3) to develop opportunities outside the United States for investments where equity interests could be built around the manufacture of products using petitioner's technology. It was also petitioner's intention that PPGI would manage petitioner's existing foreign investments. To accomplish these purposes most effectively, petitioner considered it would be advisable to place all of its export sales, foreign licensing and investment activities into a single autonomous entity under independent management.
During its formative period the affairs of PPGI were conducted by a Shareholder's Executive Board, as provided by Swiss law, which consisted of several executive officers of the petitioner. The members of the Shareholder's Executive Committee included petitioner's president, vice president and manager of the glass division, vice president and manager of the paint division, general counsel, controller, chairman of the board of directors, and the president of Columbia-Southern. When PPGI became fully *10 staffed in 1959 to engage in international business, the Shareholder's Executive Board acted in an advisory capacity to the president and management of PPGI. On August 3, 1960 the Shareholder's Executive Board was replaced by a Shareholder's Advisory Committee to act as petitioner's attorney, vote petitioner's stock in PPGI, maintain a surveillance over petitioner's investment in PPGI and report to petitioner's board of directors. Since its incorporation, PPGI has had a board of administrators which is comparable to a board of directors.
When PPGI began its operations it took over the export business previously handled by petitioner's export department and PPGE. Both the Duplate and the CPI accounts were large accounts at this time, with Duplate being PPGI's largest account. PPGI took over all agents and distributors who had previously been used by petitioner's export department and by PPGE. Most of the personnel in petitioner's export department and in PPGE became employees of PPGI.
During the years 1960 and 1961 PPGI was fully staffed to engage in international business. When PPGI began its operations in 1959 its corporate headquarters were in Geneva, Switzerland with an operating *11 branch in Havana, Cuba. Its Havana office had a staff of about 60 individuals, with 45 of the staff engaged in sales. Due to political conditions in Cuba, PPGI closed its Havana office on October 12, 1960 and three days later opened a branch in San Juan, Puerto Rico with a staff of about 45 or 50 individuals. On March 1, 1963 PPGI moved its San Juan branch to Pittsburgh. During the years 1960 and 1961 PPGI had at least three employees in its Geneva office.
At a meeting of the Shareholder's Executive Board on December 22, 1958 the basic organization of PPGI was established, placing responsibility for sales of glass, paint, chemicals and related techniques in different world areas in the several executives of PPGI who were as follows: Dwight R. Means, president and chief executive officer; John H. Henshaw, vice president; Bjorn Holmstrom, vice president and technical director; S. W. Dodge, vice president (finance); M. W. Hibschman, vice president and general counsel; and H. E. Schultz, sales and technical director (Western Hemisphere). Means, a chemical engineer with many years experience in the chemical business, had been executive vice president of Columbia-Southern. He served as *12 president of PPGI until he was forced to retire by illness in 1960 when he was replaced as president by Francis W. Theis, also a chemical engineer, who remained in that capacity until 1961. Bjorn Holmstrom succeeded Theis and served as president of PPGI from 1961 to 1963 when he was succeeded by Henshaw who has remained as president of PPGI until the present time. 1713
Before joining PPGI Henshaw had been the general export manager for petitioner from 1945 until the end of 1958 and, during the period from 1955 through 1958, he had also served as president of the Pittsburgh Plate Glass Export Corporation. From late 1961 until early in 1963 Henshaw was in charge of the Puerto Rico office of petitioner.
Henshaw, as vice president of PPGI, received total compensation in 1960 and 1961 in the respective amounts of $38,790 and $36,583. Compensation of several PPGI employees in sales (primarily on the sales manager level) ranged from about $15,200 to $21,000 annually during 1960 and 1961.
On or about December 18, 1958, the controller's office of petitioner's glass division prepared an analysis of the factory cost of eleven glass products produced by petitioner and also prepared *13 a list of proposed sales discounts for the glass products to be sold by petitioner to PPGI. The analysis showed the following facts with respect to 1/8-inch polished plate glass: Per Sg. Ft.
Trade domestic price (including Packaging) $.60
Discount of 40 percent * .24
Net price to PPGI $.36
Factory costs Inventoriable cost $.23
Factory fixed .06
Research .02
SG and Adm. .02
Total .33
Mark-up over total cost 10 percent
Projected net profit .03
In a memorandum prepared by the controller's office of the glass division under date of January 9, 1959 dealing with tentative sales discounts for glass products sold by petitioner to PPGI, it was stated that "Discounts for other products, except the low volume ones and those normally sold at a loss, were determined in proportion to 1/8-inch Polished Plate according to their profitability when sold domestically. The low and small volume products were given a flat 5% discount."
The January 9, 1959 memorandum also referred to an attached schedule which showed an estimate *14 of income from sales to PPGI based upon the 1957 export volume, using the average price of glass products sold by petitioner in 1957 to domestic customers. Such estimate of income indicated that at domestic prices the 1957 volume of glass export sales would have yielded a net income of $2,351,000, or 25.2 percent of sales ($9,323,000). On the basis of proposed prices to PPGI (using the tentative discounts in the attached schedules) the estimated net income that would be realized from the 1957 export sales volume was $502,000, or 6.7 percent of sales ($7,474,000). The memorandum stated that the costs used in making the above income estimates were based upon an overall glass division volume near the 1957 level and probably did not include all of the special type [of] packing necessary for non-Canadian exports.
Based upon the domestic price lists as shown on the December 18, 1958 analysis which was prepared by the controller's office of the glass division and using the actual price discounts as they appeared in the basic agreement subsequently executed by petitioner and PPGI on January 1, 1959 covering the terms and conditions of the sale of products by petitioner to PPGI the profit *15 (per share foot or, in the case of Clear and Solex Bent Duplate, per windshield) on the principal items of plate glass products sold to PPGI would be as shown below: 1714 Profit After
Actual 1960-
Domestic Discount Price to Total Profit to 1961 Volume
Type of Glass List Price Allowed PPGI Cost * Petitioner Discount **
1/8inch Polished $ .60 $ .234 $ .366 $ .32 $ .046 $ .026
Plate
1/4inch Polished .62 .242 .378 .335 .043 .022
Plate
1/8inch Solex .87 .435 .435 .32 .115 .091
1/4inch Solex .90 .450 .45 .355 .095 .07
Clear Bent 34.06 13.62 20.44 14.32 6.12 5.00
Duplate
Solex Bent 35.44 14.18 21.26 14.32 6.94 5.77
Duplate
Based upon (1) the price of glass products to PPGI as shown in the above *16 table and (2) the average volume discount of 5.5 percent actually granted to PPGI in 1960-1961 on glass and paint products, petitioner's net profit (per square foot) on sales of glass products to PPGI would be as follows: Price to PPGI Profit Percentage of
After Vol. Dis. Profit to
Sales
1/8-inch Polished Plate .346 .026 7.5%
1/4-inch Polished Plate .357 .022 6.2
1/8-inch Solex .411 .091 22.2
1/4-inch Solex .425 .070 16.5
Clear Bent Duplate 19.32 5.00 25.9
Solex Bent Duplate 20.09 5.77 28.7
The basic agreement executed between petitioner and PPGI defining the obligations, rights and duties of each party was made effective as of January 1, 1959, and a similar basic agreement executed between Columbia-Southern and PPGI was also made effective as of the same date. The basic agreements set forth PPGI's marketing functions, with the principal provisions in the agreements relating to requirement obligations and prices.
In determining the prices petitioner would charge PPGI for its products, initial price guidelines were prepared by Leland Hazard who had been vice president, general counsel and a director of petitioner from *17 1947 through 1958 and a director-consultant from 1959 to 1965. These guidelines reflected (1) the need of petitioner's division heads, who were responsible for the profits made on the sales of products to PPGI, to maintain their profits and (2) the need of PPGI to finance its newly undertaken and costly business activities which included opening up new markets, creating opportunities to exploit technology and creating opportunities for equity investment.
The price guidelines embodied the general principle that petitioner's price to PPGI should always yield petitioner a profit of at least 10 percent of net sales and in no event were goods to be sold at less than inventoriable cost plus 25 percent. The actual prices of individual products incorporated in the basic agreements were ultimately computed within each operating division in accordance with the price guidelines.
The basic agreement covering the sale of petitioner's glass and paint products to PPGI included the following provisions and conditions:
1. The prices to be paid for the majority of the products were set forth in schedules attached to the contract. The prices in the schedules were stated in terms of percentage of *18 discount from petitioner's published lists, schedules and other quotations of general 1715 application to the pricing of such products in the domestic market. The prices to be paid by PPGI to petitioner were subject to change in order to reflect any changes in petitioner's domestic prices. Prices on new products were to be negotiated by the parties so as to "yield [petitioner] above cost a profit margin substantially equal to the average profit margin realized by [petitioner] on sales to PPGI of the category of subject products the most nearly similar in character, quality, quantity and use to these subject products so to be priced."
2. Requisitions by PPGI for petitioner's products were to be prepared and forwarded from PPGI's branch office in Havana, Cuba to petitioner.
3. The usual terms and conditions applicable to petitioner's domestic prices were to be applicable to the sales to PPGI to the extent not inconsistent with the terms of the basic agreement.
4. Title and risk of loss with respect to the products in each shipment destined for Canada or Mexico remained in petitioner until the products were placed on board the carrier at the point of origin; and title *19 and risk of loss with respect to products in shipments destined overseas remained in petitioner until the products arrived at the point of embarkation from the United States.
5. Petitioner agreed to prepare the shipping documents as diverted by PPGI. Such shipping documents were to provide for the retention of title by PPGI to the products involved until delivery of such products by PPGI outside the United States.
6. Section 2.11 of the agreement provided for a schedule of credits to be applied quarterly to the amounts owing by PPGI to petitioner in connection with the purchase of petitioner's products. In any quarter in which the aggregate purchases by PPGI of petitioner's paint and glass products exceeded $2,000,000 there was to be a reduction in the amount payable by PPGI for such products in a percentage amount based upon a graduated scale. No discount was applicable until purchases exceeded $2,000,000 per quarter. Purchases of $2,000,000 up to $2,200,000 were to receive a discount up to three percent to be determined by interpolation. Such discount was applicable against the total purchases in the quarter including the first $2,000,000. The discount percentages increased up *20 to 10 percent for sales of $3,000,000 and above. This section of the agreement further provided as follows:
But in no event shall the aggregate amount to be paid by [PPGI] to [petitioner] for such subject products with respect to any quarter-annual period be less, after application of any reduction as above provided, than an amount which will yield to [petitioner] the aggregate inventoriable value or replacement cost, whichever is higher, of such subject products plus twenty-five percent (25%) of such value or cost.
The agreement stated that the purpose of the volume discount was to provide an inducement for PPGI to promote and expand in foreign countries trade in petitioner's products and to promote, develop, negotiate and acquire investments which would bear upon the enhancement of such trade in such products and otherwise secure and exploit profit-making opportunities, and to promote the sale and exchange of licensing of patents, technology, trade secrets and trademarks bearing upon the subject products, which intangible properties PPGI agreed to acquire from petitioner; and to assume the responsibility for and undertake the management of certain properties, stock and *21 other interests of petitioner outside the United States as might be requested by petitioner.
7. Petitioner agreed to supply (at the request of PPGI) technical services, technical personnel and facilities requisite for the making of technological surveys and market surveys and other investigations requisite to PPGI's investments outside the United States. PPGI agreed to reimburse petitioner for its expenditures.
8. PPGI agreed, at the request of petitioner and to the extent that PPGI was equipped and staffed to do so, to supply technical services, technical personnel and facilities requisite for the making of technological surveys, market surveys and other investigations desired by petitioner and to assist petitioner in the management of its holdings outside the United States, for which petitioner would reimburse PPGI for its expenditures.
The above provisions in the basic agreement covering paint and glass products are generally similar to the provisions in the basic agreement between PPGI and Columbia-Southern covering the sale of chemical products by Columbia-Southern to PPGI.
The basic agreements required PPGI to buy from petitioner, and petitioner to sell 1716 to *22 PPGI, 85 percent of PPGI's product needs. The basic agreements were to continue from year to year unless either party gave sixty days notice of termination.
On October 28, 1959 the two basic agreements were amended effective as of January 1, 1959 providing PPGI would receive a commission of two percent on all sales by petitioner and Columbia-Southern of glass, paint or chemical products destined directly or indirectly to customers (other than PPGI) outside the United States. The amendment applied only to those sales in which the customers insisted on making the purchase in the United States from petitioner after unsuccessful efforts by petitioner to persuade such customers to purchase products from PPGI. The amendments stated that such sales would be recognized as purchases by PPGI under the provisions in the basic agreements for the allowance of volume discounts to PPGI. The reason for the amendments was stated as follows: "Through an oversight the Basic Agreement did not cover sales of * * * products by [petitioner] to customers other than [PPGI], which products are destined directly or indirectly to customers outside the United States, such sales being attributable in whole *23 or in part to the sales, promotional and advertising activities of [PPGI] outside the United States."
The two basic agreements were further amended effective April 1, 1960. These amendments related in part to PPGI's difficulties in making sales in Cuba because of the Castro regime. Under the amendments petitioner agreed to pay PPGI a 15 percent commission on all direct sales of paint products to Cuban customers and an 11 percent commission on all other direct sales to Cuban customers, and Columbia-Southern agreed to pay PPGI a 10 percent commission on direct sales to Cuban customers. The petitioner-PPGI basic agreement was further amended on July 21, 1960 and again on June 5, 1961 to change the discounts on certain enumerated glass products. After Columbia-Southern was merged into petitioner on December 31, 1960 the two basic agreements and the amendments thereto were consolidated by an agreement effective October 1, 1961 between petitioner and PPGI.
The July 21, 1960 amendment increased the discounts on prices for Solargray, rough plate, Solex and Graylite window glass, while the discount for automotive bent and tempered glass was decreased. In the June 5, 1961 amendment the *24 discount on 1/8-inch and 1/4-inch plate glass (Solex) was decreased. The October 1, 1961 amendment both increased and decreased discounts on various sizes of metal edge window.
Volume discounts are common in world markets and were an integral part of the international glass trade in 1958. Petitioner granted the following volume discounts on the products PPGI sold in 1960 and 1961: 1960
Glass 5.302 percent ($458,267$8,644,097)
Paint 4.815 ($ 26,828$ 557,148)
Chemicals None
1961
Glass 5.629 percent ($419,959$7,460,137)
Fiber glass 5.755 ($ 5,755$ 100,000)
Paint 5.029 ($ 29,098$ 578,624)
Chemicals None
Petitioner's cost of manufacturing products (with the exception of the by-product caustic soda) sold domestically was the same as for the products that petitioner sold to PPGI.
In 1960 and 1961 PPGI could have purchased plate or window glass in most foreign markets for lower prices than it paid to petitioner.
Glass export sales of PPGI in 1960 and 1961 included, in addition to plate and window glass, automotive bent and tempered glass, building glass and optical glass.
In 1960 and 1961 more than one-half of the glass sold by petitioner *25 to PPGI was one-quarter inch and one-eighth inch plate glass. During this period one-eighth inch plate glass generally sold at about the same price as one-quarter inch plate glass. Throughout 1960 and 1961 the price of PPGI for one-quarter inch plate glass and one-eighth inch plate glass was consistently 39 percent below petitioner's published quotations to the trade.
For one-eighth inch plate glass the petitioner-PPGI basic agreement called for a 39 percent discount below the prices quoted in Circular Letter No. 562 dated June 27, 1956, and for one-quarter inch plate glass the petitioner-PPGI basic agreement called for a 39 percent discount below the price quoted in Circular Letter No. 559 dated June 15, 1956. The prices quoted in these circular letters for one-eighth and one-quarter inch plate glass were almost identical: 1717 Stock Sheets *
Mirror
Brackets Glazing 1/8-in. Quality 1/4-in. Glazing 1/8-in. Quality 1/4-in.
10-15 sq. ft. $.51 $.51 $.57 $.57
15-25 .51 .51 .59 .59
25-50 .53 .53 .63 .63
50-75 .56 .66
75-100 .57 .70
100-120 .62
120-200 .91
*26 Cut Sizes *
Mirror
Brackets Glazing 1/8in. Quality 1/4in. Glazing 1/8in.
Up to 1 sq. ft. $.27 $.27 $.34
1-2.67 .34 .34 .38
2.67-5 .46 .46 .49
5-7 .51 .51 .54
7-10 .58 .58 .60
10-15 .60 .60 .63
15-75 .60 .60 .66
25-50 .69 .65 .69
50-75 .69
75-100 .75
100-120 .82
120-200 1.16
Cut Sizes *
Mirror Mirror
Brackets Quality 1/4in. Silvering 1/8in. Quality 1/4in.
Up to 1 sq. ft. $.34 $.36 $ .36
1-2.67 .38 .40 .40
2.67-5 .49 .51 .51
5-7 .54 .56 .56
7-10 .60 .62 .62
10-15 .63 .65 .65
15-75 .66 .68 .68
25-50 .69 .71
50-75 .80 .82
75-100
100-120
120-200
Petitioner's published quotations to the domestic trade were not firm prices but rather were the starting point for negotiated prices.
*27 During 1960 and 1961 one-eighth inch plate glass was produced in Europe and after 1959 such European plate glass competed in the United States with domestic plate glass.
In 1960 and 1961 United States domestic chemical prices were higher than the prices in most of the markets in which PPGI sold chemical products. In 1960 and 1961, due to the depressed state of some chemical prices, the prices petitioner charged PPGI for chemical products were too high to permit PPGI to earn a fair profit on these products. PPGI repeatedly bargained for lower prices. On occasion, PPGI persuaded petitioner to increase its discounts for chemical products.
For a period of more than 60 years that ended in the early 1950's W. P. Fuller Company, an unrelated corporation, was petitioner's independent West Coast distributor purchasing petitioner's products (primarily glass) for resale. Petitioner made shipments to Fuller's warehouses as well as directly to Fuller's customers. Petitioner gave W. P. Fuller Company an extra discount on glass ranging from 5 to 15 percent, which discount was comparable to the volume discount subsequently granted by petitioner to PPGI. The Fuller discount applied to shipments *28 made from petitioner's factories directly to Fuller's customers. These direct shipments were a substantial portion of petitioner's sales to Fuller.
In the 1950's Columbia-Southern in a long-term contract for the sale of chlorine to Union Carbide Corporation granted the purchaser a special discount equivalent to a volume discount with the result that the net price was substantially lower than the normal domestic market price.
Petitioner paid PPGI a two percent commission on all direct export sales. The bulk of the commission sales was of chemical products. The commission was paid on sales to PPGI's customers who wanted to take delivery in the United States or to customers who, during PPGI's formative period, insisted on being invoiced by petitioner for a variety of reasons.
The commission of two percent was compensation for the substantial sales functions performed in connection with the commission sales and was also intended to compensate PPGI for providing a worldwide marketing staff and marketing network for 1718 petitioner's products. In some instances the commission was paid on sales by petitioner to competitors of PPGI such as brokers who had bid successfully on business *29 in direct competition with PPGI.
In 1961 PPGI worked for about three months through an agent in Turkey to get a sizable caustic soda order. PPGI lost the business to Imperial Chemical Industries, Ltd., a leading United Kingdom chemical producer. Imperial Chemical had underbid PPGI with caustic soda purchased from petitioner for a price less than the price at which petitioner had offered the material to PPGI. The caustic soda sold by Imperial Chemical in Turkey had a value of approximately $230,000 to $240,000.
In 1961 PPGI had nearly completed a $188,000 sale in Indonesia of anhydrous caustic soda only to learn that the Central Bank of Indonesia had ruled that the payee of a letter of credit must be a resident of the country of origin of the merchandise. As a consequence, petitioner had to invoice the sale.
Under a 1954 agreement with Columbia-Southern, Columbian Carbon Co. (a domestic corporation) bought silica pigment products from Columbia-Southern for resale outside the United States and Canada. PPGI called upon foreign agents of Columbian Carbon to determine the international market for these products and such information, which was not available from Columbian Carbon, was *30 supplied to Columbia-Southern. Use of such information enabled Columbia-Southern to adjust its output and increase its sales. In 1960 the annual sales to Columbian Carbon were approximately $500,000.
From April 1, 1960 (the effective date of the amendments to the basic agreements giving PPGI commissions ranging from 10 percent to 15 percent on direct sales by petitioner to customers in Cuba) through December 31, 1960, petitioner paid commissions to PPGI for its efforts in helping petitioner make direct sales of approximately $40,000 to Cuba.
Commissions paid to PPGI in 1960 on export sales of glass and paint products made by petitioner amounted to about $14,000 and about $25,000 in 1961. Commissions paid to PPGI on export chemical sales amounted to about $74,000 in 1960 and $35,000 in 1961.
Pittsburgh Corning Corporation (hereinafter called Pittsburgh Corning) was owned by petitioner and Corning Glass Works in equal shares. Corning Glass Works was unrelated to petitioner.
PPGI and Pittsburgh Corning entered into an agreement effective January 1, 1960 which provided that PPGI would be the exclusive agent of Pittsburgh Corning in designated foreign countries for the sale of "subject *31 products" manufactured by Pittsburgh Corning which included glass blocks, Foamglas insulations and refractory materials. The agreement made PPGI the exclusive agent of Pittsburgh Corning in all foreign countries other than Canada with respect to such products, except that for Foamglas insulation most European countries and the United Kingdom were excluded from the agency territory.
The agency agreement between PPGI and Pittsburgh Corning included the following provisions:
1. PPGI agreed to conduct its operations in behalf of Pittsburgh Corning through offices and subagencies in the designated foreign countries to be maintained at the expense of PPGI. PPGI could elect not to disclose to customers that Pittsburgh Corning was its principal. All orders for Pittsburgh Corning products destined to countries covered by the agency agreement were to be routed exclusively through PPGI and all inquiries for Pittsburgh Corning products from such countries were to be referred to PPGI.
2. Pittsburgh Corning agreed to prepare all shipping documents at its own cost.
3. PPGI agreed to prepare collection invoices and forward them to customers of Pittsburgh Corning products. Amounts collected *32 by PPGI were to be remitted to Pittsburgh Corning. PPGI assumed the credit risk and agreed to indemnify Pittsburgh Corning for accounts remaining unpaid for one year after date of shipment, less PPGI's commissions.
4. Pittsburgh Corning agreed to inform PPGI from time to time of the specified quantities of subject products available for sale in the designated countries, together with the prices, terms and conditions under which orders for such products could be taken by PPGI on behalf of Pittsburgh Corning. PPGI agreed to solicit orders and transmit them to Pittsburgh Corning for acceptance, confirmation and shipment.
5. Pittsburgh Corning agreed to pay to PPGI commissions of 10 percent of the 1719 sales price of glass products and 7 1/2 percent of the sales price of Foamglas. If the invoice price to a customer was greater than Pittsburgh Corning's applicable distributor price, then Pittsburgh Corning would pay the excess to PPGI in addition to the commission. The commissions due PPGI were payable upon receipt of payment by Pittsburgh Corning.
6. The term of the contract was for one year and then from year to year if each party notified the other within 60 days prior to *33 the end of the year of its intention to continue the agreement. The agreement was subject to termination by either party at any time on 60 days written notice. When the agreement terminated, there would be an accounting between the parties and PPGI would be paid commissions with respect to sales for which Pittsburgh Corning had received payment, with the remaining compensation to PPGI payable when Pittsburgh Corning received payment.
PPGI sold the Pittsburgh Corning products through the same agencies that handled the glass products produced by petitioner. The same agency contracts covered the products of both petitioner and Pittsburgh Corning. PPGI generally paid its agents a commission of 5 percent on glass blocks and 4 percent on foamglass insulation. The principal products of Pittsburgh Corning handled by PPGI were glass blocks.
PPGI carried on all correspondence and billings on its own letterheads and billheads.
PPGI received commissions in the amounts of $63,696 and $96,182 in 1960 and 1961, respectively, from the sale of Pittsburgh Corning products. The gross sales by PPGI of Pittsburgh Corning products in 1960 and 1961 were in the approximate amounts of $616,000 and $706,000, *34 respectively.
The agency agreement between PPGI and Pittsburgh Corning was an arm's length transaction. In 1964 PPGI terminated the agency with respect to Foamglas because it became unprofitable at the 7 1/2 percent commission rate.
PPGI performed the following functions with its independent marketing organization: (1) determined which existing markets to expand and which new markets to try to create; (2) determined the method and means of exploiting markets; (3) determined how to service customers; (4) determined what products to promote; (5) determined prices for its various products in the various markets; (6) determined the form of payment as well as the credit terms for customers and (7) determined methods of shipment and means for expediting shipment.
PPGI was able to expand the export markets it acquired from petitioner, petitioner's export corporation (PPGE) and Columbia-Southern. PPGI substantially increased the sales of glass products to CPI (the Canadian corporation controlled by petitioner). In 1960 PPGI made net sales of glass products to CPI in the amount of $814,990 and in 1961 the net sales to CPI increased to $1,335,709. During the period from 1959 through 1967 *35 PPGI's sales to CPI have approximately tripled.
In 1959 PPGI had 86 export glass customers, all of them acquired from petitioner and its export corporation (PPGE). By 1965 PPGI had increased the number of its export glass customers to 568 and by 1967 to more than 700.
Through the year 1961 petitioner's Canadian subsidiaries, Duplate and CPI, were managed by W. Eric Phillips who was also a director and stockholder of petitioner. The operation of these Canadian subsidiaries by Phillips was autonomous. CPI, which was wholly owned by petitioner in 1960 and 1961, was a glass and paint distributor. It sold glass to users of the product (manufacturers) as well as to dealers. It also performed contract work, such as glazing buildings. Duplate, which was two-thirds owned by petitioner in 1960 and 1961, fabricated glass parts for the automotive original equipment market in Canada, the largest single Canadian market for glass products. Its customers consisted of the Canadian subsidiaries of General Motors Corporation, Ford and Chrysler. Duplate's sales to these customers were on a yearly contract basis. In addition to automotive parts Duplate fabricated double glazed units, aircraft windshields *36 and a wide variety of tempered glass for the building trade. Standard Chemical, which was wholly owned by petitioner in 1960 and 1961, was a distributor and manufacturer of chemicals in Canada.
Petitioner's sales account with Duplate, beginning before petitioner acquired control of Duplate, had grown over a period of years when it was handled by petitioner's export department and it became PPGI's largest customers when PPGI went into operation. The sale of petitioner's products to CPI was similarly a large account when PPGI was formed. 1720
PPGI executed written agreements with Duplate and CPI effective as of January 1, 1959 and with Standard Chemical effective February 1, 1960. Under the CPI agreement, CPI was obligated to purchase from PPGI 35 percent of CPI's annual requirements for plate glass, sheet glass and special glass products not produced in Canada and PPGI was obligated to sell to CPI up to 85 percent of CPI's requirements for such products. The amount of the purchases between 35 percent and 85 percent were to be set by CPI. The percentage requirements were limited to products not produced in Canada. Under the CPI agreement all prices charged by PPGI were to *37 be as favorable as those PPGI charged any other jobber or mirror manufacturer. The Duplate agreement (covering plate glass and sheet glass products) was substantially similar to the CPI agreement except that PPGI's prices had to be as favorable as PPGI's prices to any of its customers. Under the Standard Chemical agreement it was obligated to purchase from PPGI 60 percent of Standard Chemical's annual requirements for non-Canadian products. Under the Standard Chemical agreement all prices were to be competitive with those available to Standard Chemical from other sources. A cash discount of one percent was allowed under the agreements on all sales to Duplate and CPI.
PPGI's agreements with Duplate and CPI contained price schedules for most of the glass products involved. The prices for products not specified in the schedules were to be those set forth in PPGI's price list applicable to the Canadian market. The prices designated in the schedules were to point of entry in Canada designated by Duplate or CPI, with freight collect, but with freight equalization to be allowed from certain points of origin in the United States.
During the period when PPGI had its office in Havana, it *38 was linked with petitioner's foreign service departments by teletype service. No teletype service existed between the Havana office and petitioner's Canadian subsidiaries. When PPGI moved its office to Puerto Rico teletype service linked it both to the Canadian subsidiaries of petitioner as well as to petitioner's foreign service departments.
The bulk of the glass sold by PPGI to Duplate in 1960 and 1961 was plate glass which Duplate used to laminate, bend and cut to shape for automotive uses. Substantially all of the glass used by Duplate for laminating was purchased from PPGI.
No distinction was made with respect to Canadian shipments in establishing the prices paid by PPGI to petitioner. PPGI obtained the same discounts on the shipments to Canada as on sales to customers in other countries. Shipments to the Canadian subsidiaries were made by rail and truck from petitioner's warehouses and factories in the United States.
The records of PPGI indicate that its total gross income from the sale of glass products to Duplate and CPI (computed after deductions from sales of freight equalization, outgoing transportation and volume discounts) amounted to approximately $2,611,000 in *39 1960 and 1961, and its total gross income (similarly computed) from the sale of glass products to others during these two years amounted to about $1,369,000.
On occasion Compagnie de Saint Gobain, an important producer of glass products in Europe, has used one of its subsidiaries, Claritude Ltd., to sell glass products to another of its subsidiaries, Improglass Ltd.
At least until the year 1959 CPI bought glass products from several domestic and European glass producers unrelated to petitioner. During 1960 and 1961 CPI did not limit its purchases of glass products to PPGI but also obtained such glass products from at least one other manufacturer, Compagnie de Saint Gobain. At least until the year 1959 Duplate also purchased glass products from European glass manufacturers as well as from petitioner. During the years 1960 and 1961 Duplate continued to purchase glass from suppliers other than PPGI. During the years 1960 and 1961 Standard Chemical purchased substantial quantities from producers unrelated to petitioner.
In 1959 PPGI made sales of glass products to customers other than petitioner's Canadian Subsidiaries (Duplate and CPI) of about $2,500,000. By the end of 1967 these *40 sales had increased to about $7,500,000. PPGI also increased the sales of chemical products over the years to Standard Chemical (petitioner's controlled Canadian Subsidiary) and to customers in Asian, Middle Eastern and African markets.
PPGI increased the export sales of paint products from 1960 through 1967, a period marked by increasing competition from local manufacturers of such products in the foreign markets. In 1960 PPGI sold paint 1721 products in the amount of $600,000 or $700,000 and during the first quarter of 1968 its paint sales were at an annual rate of about $3,000,000. In 1959 PPGI had approximately 154 export paint customers, most of them acquired from petitioner and from PPGE (the export corporation). By 1965 PPGI increased this number to 240 and by 1968 to over 300 export paint customers.
PPGI was able to create new export markets for petitioner's products. PPGI had a small volume of business in Europe in 1960 and 1961. Subsequently, PPGI succeeded in creating substantial new markets in various European countries. PPGI opened new markets for petitioner's glass products in Australia, New Zealand and Brazil and also opened new markets for petitioner's chemical *41 products in Argentina and Mexico.
Since its formation in 1959 PPGI adopted an aggressive, flexible price policy enabling it to meet competitive prices in the various markets of the world. In 1960 and 1961 PPGI's sales personnel constantly kept informed of the prices its competitors charged in the world markets. PPGI made adjustments from time to time in the price of glass to Duplate (petitioner's controlled Canadian subsidiary) so that Duplate could sell fabricated glass to Canadian automotive manufacturers and other customers at competitive prices. PPGI also made adjustments from time to time in the price of glass sold to CPI (petitioner's controlled Canadian subsidiary) to enable CPI to meet competition in the Canadian market from other suppliers. These adjustments to the prices charged to CPI included advertising allowances, rebates and commissions on certain glass shipments.
In making sales of glass products in foreign markets PPGI followed the prevailing custom of granting various discounts on such sales, including cash discounts, volume discounts and discounts for membership in an association. Where necessary, PPGI reduced prices and sold products at a loss in order to obtain *42 and keep a foothold in certain markets.
PPGI worked directly with freight forwarders and shipping companies to reduce freight costs of its chemical sales. In connection with sales of caustic soda in Argentina PPGI devised a plan for shipping liquid caustic soda instead of anhydrous caustic soda thereby realizing a reduction in freight costs.
PPGI had a marketing organization which was adequately staffed to deal with the various aspects of export marketing, including customer contact and service, contract negotiations, marketing research, technical assistance and credit arrangements. In marketing petitioner's products PPGI relied in part on a network of foreign commission agents or representatives. PPGI had a sales manager, with assistants, for each of the main product lines it sold, i. e., glass products, paint products and chemical products.
During the period from 1959 through 1961 PPGI executed approximately 50 agency agreements with agents in numerous foreign countries and foreign areas in South America, Europe, Africa, the Near East and Asia covering the sale of glass products, paint products and chemicals. PPGI expanded the number of its foreign commission agents for chemical *43 products from about 19 or 20 early in 1959 to about 30 or 31 by the end of 1961.
Generally, an agency covered a territory of one or more countries. A typical agency contract provided that the agent would be the sole and exclusive agent in the designated country or countries for the listed products. The agency might be for both glass and paint products or only one of them. The agent was to conduct his operations through offices and sub-agencies and all orders were to be forwarded to PPGI's Havana office or its Santurce (Puerto Rico) office. All orders for shipments were to be routed exclusively through the agent and every inquiry that PPGI might receive from the agent's territory for any of the listed products was to be referred to the agent unless otherwise specified by the customer. PPGI was to keep the agent informed of the specific quantities of products available for sale in his territory and the relevant prices, terms and conditions. The agent was to furnish PPGI with full information as to the customer's financial and credit standing. All orders were subject to acceptance by PPGI. Provision was made for insurance on shipments. The agency contract continued from year to year *44 and was terminable on 60 days notice from the end of the year. When an agreement terminated, an accounting would be made between PPGI and the agent, with the agent being paid commissions on sales for which PPGI had received payment - otherwise the agent's commissions would be payable when PPGI received payment from the customer.
The agency contracts covered the products of both petitioner and Pittsburgh 1722 Corning Corporation. Agents were paid commissions ranging from 1 1/2 percent to 15 percent. Generally, however, the agents were paid a commission of 5 percent on glass products with the exception of a 4 percent commission on Foamglas insulation, a commission of 10 percent on special glass orders, a commission of 5 percent on industrial paint and 10 percent on other paint products.
PPGI's marketing staff had full responsibility for sales trips and about one-half their time was spent in travelling. Such trips resulted in increased sales and also served to tighten PPGI's marketing organization. PPGI kept in close contact with its major customers, such as Duplate and CPI, making adjustments in terms and prices to enable customers to meet their competition and expediting the *45 delivery of products when necessary. PPGI made constant efforts to service its customers, assisting them in marketing the products PPGI sold to them, tailoring the products to meet the competition encountered by the customers and making other efforts to improve the quality of the service PPGI offered to its customers. PPGI also sold products for unrelated manufacturers.
PPGI made market studies for petitioner's chemical products to determine the potential of old and new markets.
In 1960 and 1961 PPGA (the wholly-owned subsidiary of PPGI in Argentina) had alkali storage tanks in Argentina. PPGI also had an alkali storage tank in Cuba. PPGI had some inventories in transit and in bonded warehouses and some few commission agents of PPGI kept inventories. Generally, however, PPGI ordered products directly from petitioner and petitioner would send them directly to PPGI's customers.
PPGI carried marine and war risk insurance on all shipments and, upon request, would take out insurance covering all risks from warehouse to warehouse, covering such items as breakage, water damage and other contingencies.
PPGI bore the credit risk on all sales. Its controller-general worked with the marketing *46 staff on credit matters. PPGI's customers for the most part paid PPGI anywhere from 30 to 180 days. PPGI however would generally pay petitioner within 10 days from the date of billing and no later than 30 days.
In 1960 and 1961 PPGI paid for advertising materials such as color cards, booklets and other sales literature it used to promote sales.
Much of PPGI's export business consisted of small sales scattered throughout the world and it was necessary to meet the differing quality and packing requirements of this multiplicity of customers. PPGI's agents supplied the necessary shipping instructions which were obtained by the agents from the customers. PPGI's marketing organization was prepared to deal with most of the major languages of the world as well as the laws and customs and documentary requirements of various foreign countries.
All customer complaints were directed to PPGI, which dealt with such complaints and took whatever action was required. In the case of glass and paint products PPGI, directly or indirectly (through the petitioner's foreign service departments) made every effort to expedite shipments to customers. In the case of chemicals, PPGI expedited shipments *47 directly by contacting the plant of origin.
Petitioner established special departments to service some of its larger customers. It created the Detroit Automotive Glass Sales office to service the Detroit automotive manufacturers, to market products and to perform other general marketing functions. Petitioner also organized two foreign service departments, one for glass products and one for paint products. The petitioner's foreign service department for glass products performed the following functions for PPGI: (1) received PPGI's sales orders and routed them to the appropriate factory; (2) expedited these orders in accordance with instructions from PPGI; (3) prepared necessary export documents; (4) notified PPGI of petitioner's prices for new glass products upon request; (5) acted as PPGI's liaison with petitioner in obtaining the technical, commercial and other information requested by PPGI.
The preparation of invoices and the expediting of shipments were the largest activities of petitioner's foreign service department (glass). Invoices on Canadian sales were sent to a bank in Canada for endorsement and passage of title in Canada. Invoicing of foreign shipments by the foreign *48 service department (glass) was complicated by the details involved and the requirements of timely mailing to Canada for endorsement without incurring demurrage charges on shipments. 1723
PPGI sent its orders for glass products to the foreign service department (glass) from Havana by teletype and from Puerto Rico by Telex. PPGI confirmed all wired orders by mail. The foreign service department (glass) had 12 employees in 1959 and 10 when it was disbanded in 1963. In 1960 the cost of operating the foreign service department (glass) was $126,183 and in 1961 the cost was $125,995. In 1960 the salary of John de Bruyn Kops, the coordinator of the foreign service department (glass), was $16,700 and in 1961 it was $17,200. He formerly had been petitioner's sales representative to the Canadian glass trade (1946-1952) and then General Sales Manager of CPI's Window Glass division. In 1960 and 1961 the next highest paid employee in petitioner's foreign service department (glass) earned less than $7,000 per year.
Petitioner's foreign service department (paint) performed the following functions for PPGI; (1) received sales orders from PPGI and routed such orders to the appropriate factories; *49 (2) expedited the sales orders in accordance with instructions from PPGI; and (3) supplied prices of petitioner's new paint products to PPGI upon request. This department consisted of four employees with a coordinator, Robert E. Kenward. During the period he served as coordinator, Kenward also performed other duties for petitioner unrelated to export sales.
At a meeting of petitioner's board of directors held on December 12, 1962, the impact of the Revenue Act of 1962 on the operations and organization of PPGI was discussed and the decision was reached to move PPGI's trading office from Puerto Rico to Pittsburgh. The board of directors also voted to elect to use the minimum distribution provisions of the Revenue Act of 1962 for all controlled foreign subsidiaries considered as a group. The board further decided (1) that petitioner would make no more transfers of technology to PPGI; (2) to amend existing agreements for the sale of technology by petitioner to PPGI by eliminating PPGI's obligation to make prescribed installment payments and to substitute therefor PPGI's obligation to pay petitioner 70 percent of PPGI's gross income from licenses of such technology until the full amount *50 of PPGI's outstanding obligation was paid; and (3) that petitioner should purchase PPGI's investments in various countries.
The move by PPGI of its trading office from Puerto Rico to Pittsburgh reduced PPGI's expenditures by approximately $150,000 per year, which reduction included the Telex service expenditures of about $50,000 per year. A reduction in the number of employees also contributed to the decrease in expenditures after the move to Pittsburgh. Most of the personnel in petitioner's foreign service departments were integrated into the PPGI organization in 1963 with some 14 employees (formerly with petitioner's foreign service department) replacing a like number of employees who had worked for PPGI in its Puerto Rico office. The move to Pittsburgh also eliminated the extra compensation for PPGI's employees while they worked in Havana and Puerto Rico.
During the period 1959 through 1961 PPGI had personnel experienced in licensing glass, paint and chemical technology in foreign countries. PPGI only acquired technology from petitioner when it appeared that PPGI could profitably exploit such technology in the near future. PPGI generally had five or six employees in the field *51 contacting potential licensees and it was active in the effort to acquire new licensees, furnishing them with assessment data and other detailed information bearing upon the profitable uses of a license. PPGI serviced its licensees by forwarding them updated technology and marketing reports and kept informed of the needs of its licensees. PPGI also arranged meetings between licensees and petitioner's technical staff when necessary. Petitioner was compensated for its services to PPGI's licensees.
After the adoption of the Revenue Act of 1962 petitioner's board of directors decided to license technology directly and PPGI performed services for petitioner in connection with the transfers of technology by petitioner to third parties. PPGI was not compensated for these services.
From 1959 through 1961 PPGI explored opportunities outside the United States for investments in new or existing companies capable of using petitioner's technology. PPGI's staff made intensive studies and marketing surveys in different world areas. On occasion PPGI retained professional counsel to make studies of foreign investment opportunities.
From its organization through 1962 PPGI made the following investments: *52 (1) a 50/50 joint venture with A.K.U., a Dutch company, to form N. V. Silenka 1724 A.K.U., a Dutch company engaged in the manufacture of fiber glass yarn in The Netherlands; (2) a 50/50 joint venture with Rumianca, S. p. A., a large Italian chemical company, to form Chimica Sarda, S. p. A., an Italian company engaged in the production of chlorinated hydrocarbons in Sardinia; (3) entered into a joint venture with Societa Edison to form Pennitalia, S. p. A; an Italian company engaged in the production of sheet glass in Salerno, Italy. PPGI had more than a 50 percent interest in Pennitalia; (4) a wholly-owned Argentine subsidiary (Pittsburgh Plate Glass Argentina) to engage in the warehousing and distribution of petitioner's chemical products. PPGI capitalized this subsidiary with approximately $300,000; (5) acquired a 25 percent interest in Les Usines J. G. deConinck & Fils, S.A., a Belgian paint manufacturer, in consideration for cash plus the right to use PPGI's paint and coating technology; (6) acquired a 7 1/2 percent interest in Les Soudieres Reunies La Madeleine-Varangeville, S.A., a French chemical producer, in exchange for the right to use PPGI's soda ash technology; and *53 (7) acquired more than a 50 percent interest in a French paint manufacturer (Peintures Corona & Huileries De Valencienes).
From its organization through 1962 PPGI studied a number of investment opportunities that, for various reasons, it did not pursue such as (1) the economic feasibility of constructing sheet glass factories in Argentina, Puerto Rico, Jamaica and India (2) the economic feasibility of constructing a fiber glass plant in Chile; (3) the economic feasibility of constructing cement plants in Argentina, Puerto Rico and Jamaica; (4) the economic consequences of acquiring paint factories in Brazil, Venezuela, Mexico and France; and (5) the economic consequences of investments in a chromium chemicals plant in Mexico, soda ash plants in India and Brazil and a chlorin-caustic soda plant in Australia.
Following the enactment of the Revenue Act of 1962 petitioner acquired PPGI's interests in N. V. Silenka, A.K.U., Chimica Sarda, S. p. A., Pennitalia, S. p. A. and Peintures Corona & Huileries De Valencienes.
From 1959 through 1961 PPGI managed all of petitioner's foreign investments outside of Canada. On September 30, 1960 petitioner transferred its direct holdings in the *54 following companies to PPGI as a contribution to PPGI's capital: Cristalerias de Chile, S.A.;C.V.B.; Cia Vidraria Santa Marina; and Cristalerias Rigolleau, S.A.
In 1960 and 1961 Societe Anonyme des Glaces de Courcelles, a Belgian glass distributor, was a wholly-owned foreign subsidiary of petitioner. Nearly all of Courcelles's sales were of one-quarter inch plate glass purchased in stock sheets from Franiere, a Belgian subsidiary of Compagnie de Saint Gobain (a large scale producer of plate and window glass). Courcelles cut and packed the glass it purchased from Franiere and resold it chiefly to customers in Europe and also to customers in numerous other world markets.
In 1960 and 1961 PPGI purchased 2,703,000 square feet and 3,450,000 square feet, respectively, of one-quarter inch plate glass from petitioner. PPGI had a contractual right under the basic agreement with petitioner to purchase uncut and unpacked one-quarter inch plate glass in stock sheets, after allowance for a 39 percent discount and a 5 percent volume discount from list price, at net prices of about $.29 per square foot in the 10-25 square feet bracket to about $.52 per square foot in the 120-200 square feet bracket.
*55 In 1960 PPGI paid petitioner $.36 per square foot for one-quarter inch plate glass before the volume discount. After a volume discount of about 5.302 percent received by PPGI for glass purchased in 1960 the net price to PPGI for one-quarter inch plate glass was $.34 per square foot. In 1961 PPGI paid petitioner $.34 per square foot for one-quarter inch plate glass before the volume discount. After a volume discount of about 5.629 percent received by PPGI for glass it purchased in 1961 the net price to PPGI for one-quarter inch plate glass was $.32 per square foot.
In 1960 and 1961 the sales by petitioner's glass division to PPGI of one-quarter inch plate glass amounted to $972,000 and $1,164,000 respectively. In 1960 and 1961 the sales of one-eighth inch plate glass by petitioner's glass division to PPGI amounted to $3,068,000 and $2,866,000 respectively. Throughout 1960 and 1961 the market price for one-eighth inch plate glass was identical or nearly identical with the market price for one-quarter inch plate glass.
In 1960 and 1961 PPGI paid substantially the same price to petitioner for 1725 one-eighth inch and one-quarter inch plate glass.
In 1960 and 1961 Courcelles *56 paid an average of approximately $.20 per square foot for stock sheets of one-quarter inch plate glass purchased from Franiere. Courcelles' total costs during this period after direct cutting and packaging expenses and fixed, selling, general and administrative expenses were an average of approximately $.41 per square foot. Courcelles' net sales prices during this period were an average of about $.48 or $.49 per square foot for the one-quarter inch plate glass. Courcelles' cost of cutting and packing averaged 7.7 cents in 1960 and 8.4 cents in 1961.
In 1960 and 1961 petitioner cut and packed the 10-25 square feet sizes of glazed quality one-quarter inch plate glass for $.09 per square foot. In the brackets 25-50 square feet and higher, this cost ranged from $.12 to $.25 per square foot.
In 1960 and 1961 the Franklin Glass Company was a domestic manufacturer and distributor of plate glass with a plant in Butler, Pennsylvania. In 1960 and 1961 the Franklin Glass Company was not related to petitioner. During these years petitioner sold a substantial amount of plate glass products to the Franklin Glass Company at prices lower than those it charged PPGI. On one-quarter inch plate glass *57 petitioner charged Franklin Glass Company from $.01 to $.06 per square foot less than it charged PPGI, depending on the size bracket. On Solargray glass petitioner's prices to Franklin Glass Company were from $.03 to $.17 per square foot less than the prices it charged PPGI, depending on the size bracket.
In 1960 and 1961 DuPont sold Dulux and Duco automotive refinishing materials to outside distributors at lower prices than PPGI was able to buy comparable products from petitioner. During this same period PPGI bought some federal specification paints, including such items as spray can coatings, from outside suppliers at lower prices than PPGI was able to buy comparable paints from petitioner.
In 1961 petitioner sold caustic soda in the amount of approximately $230,000 to $240,000 to Imperial Chemical Industries, Ltd. (a leading chemical producer in the United Kingdom and a competitor of PPGI) at a price lower than the price PPGI was then paying petitioner for such product. In 1961 Columbia-Southern sold about 70,000 tons of liquid caustic soda to the Olin Mathieson Company for $25 per ton. In 1961 PPGI paid petitioner about $27 per ton for a substantial amount of such caustic soda.
*58 Except for a determination of pre-tax profits from the paint sales to PPGI in 1959, 1960 and at least a part of 1961, the petitioner did not make any determinations in its books and records or financial statements of its pre-tax profits for 1960 and 1961 from sales to PPGI or from commission export sales. In 1967 petitioner's counsel retained C. Paul Jannis, a certified public accountant and a partner in Price Waterhouse & Co., to determine petitioner's profit on these sales.
PPGI's audited and unaudited financial statements for 1960 cover the 13-month period from December 1, 1959 through December 31, 1960. PPGI's audited financial statements for 1960 and 1961 do not show PPGI's trading profit by product group. However, the unaudited financial statements of PPGI for 1960 and 1961 show trading profit by product group.
C. Paul Jannis in March 1968 undertook the assignment to determine the net income or trading profit of PPGI by product groups for the years 1960 and 1961. He undertook to divide PPGI's trading profit into four major product groups - glass, fiber glass, paint and chemicals; to subdivide glass into CPI, Duplate and other sales; to subdivide chemicals into Standard *59 Chemical, PPGA and other sales; and to reconstruct PPGI's operating statements for the years 1960 and 1961.
Petitioner's books and records and internal financial statements contain information on profitability by four basic organizational units. In 1960 and 1961 petitioner's glass division was subdivided into three profit centers, each consisting of a product group: (1) window glass; (2) plate glass; and (3) building and optical products. In 1960 and 1961 petitioner's chemical division was subdivided into 15 profit centers, each consisting of a product group: (1) soda ash; (2) chlorine; (3) caustic soda; (4) calcene and silica pigments; (5) calcium chloride; (6) titanium tetrachloride; (7) hypochlorites; (8) solvents and chlorobenzenes; (9) agricultural chemicals; (10) ammonia; (11) chrome products; (12) hydrogen peroxide; (13) barium products; (14) Barberton cement; and (15) E.D.C. & miscellaneous. In 1960 and 1961 petitioner's fiber glass division and 1726 its paint and brush division each constituted a profit center.
Petitioner's books and records and internal financial statements are set up to show the profit contribution and net profit of each profit center. Sales are *60 broken down in the books and records into major categories. For instance, the plate glass profit center included such sub-categories as Detroit automotive sales and export sales. With the exception of the internal financial statements of the paint and brush division for 1960 and 1961 which indicate the net profit (or loss) on sales to PPGI, the petitioner's books and records and internal financial statements do not show the net profit for the different sales categories but do reflect their profit contribution.
To determine the net profit of petitioner's export sales Jannis used the profit contribution method. Profit contribution is the excess of net sales over inventoriable costs (cost of goods sold). Under the profit contribution method all costs of a profit center that can be directly traced to a particular type of sale are allocated to that sale, and all common costs of a profit center are allocated to a particular type of sale by the ratio of the profit contribution of that type of sale to the total profit contribution of that profit center. The common costs allocated by Jannis using the profit contribution method were period or fixed costs of production, research, engineering, *61 selling, advertising, general and administrative expenses.
From the books and records and internal financial statements of petitioner Jannis obtained the net sales to PPGI and the inventoriable costs of such sales for each of the three profit centers in the glass division, for all of the 15 profit centers of the chemical division except for caustic soda, for the paint and brush division and for the fiber glass division. He obtained from trial balances and from contemporaneously prepared reports the volume discounts that petitioner granted PPGI and allocated them to petitioner's profit center in accordance with net sales. He obtained the net commission export sales for petitioner's fiber glass division and for the three profit centers in the glass division from contemporaneously prepared quarterly reports. He obtained the net commission export sales for petitioner's paint and brush division from petitioner's internal financial statements. Because it was impossible to obtain the inventoriable cost of the products sold in commission sales in the glass, paint and brush, and fiber glass divisions, Jannis obtained the inventoriable cost of such sales by multiplying the total inventoriable *62 cost for each profit center by the ratio of that profit center's net commission export sales to the total net sales.
Jannis obtained the net commission export sales for all of the 15 profit centers in petitioner's chemical division (except for caustic soda) from petitioner's internal financial statements. He obtained the inventoriable cost for the chemical products sold in commission export sales from petitioner's books and records and internal financial statements.
In 1960 and 1961 petitioner was a large producer of chlorine and caustic soda in the United States. During these years petitioner had the following chemical plants ranked in order of size of potential caustic soda and chlorine production: (1) Lake Charles, Louisiana; (2) Natrium, West Virginia; (3) Barberton, Ohio; and (4) Corpus Christi, Texas. Under the electrolytic process used by petitioner for producing chlorine, electricity is passed through a brine solution causing the brine to disassociate into chlorine gas and sodium. The sodium reacts with the water present to form hydrogen and caustic soda. Due to the chemical nature of salt it is inevitable that for each atomic weight unit of chlorine produced by electrolysis *63 1.1 atomic weight units of caustic soda are produced.
Petitioner and other segments of the chemical industry consider the caustic soda resulting from the electrolytic production of chlorine as a by-product. In the last 15 to 20 years the demand for chlorine has grown at a far greater pace than the demand for caustic soda. Among the growing uses for chlorine are chlorinated synthetics, polyvinyl chloride, chlorinated organics (including cleaning solutions), chlorinated pigments and the use of chlorine for treating municipal water supplies and bleaching.
By 1956 the electrolytic process supplied all the caustic soda required in the United States. By 1957 the total caustic soda produced in the United States by the electrolytic process exceeded the sales and ordinary uses of such caustic soda.
In 1952 petitioner's surface storage capacity for caustic soda was 55,000 tons and by September 1960 it had reached 172,000 1727 tons. In 1960 petitioner's total caustic soda production was about 600,000 tons and in 1961 it was about 580,000 tons. By 1960 petitioner's caustic soda storage tanks were completely full and it was not economically feasible for petitioner to continue building *64 new storage facilities. Caustic soda is hazardous and during 1960 and 1961 the disposition of caustic soda was curtailed by pollution abatement statutes.
In 1960 and 1961 petitioner attacked the immediate problem of excess caustic soda in three ways: (1) it investigated and found some additional internal or captive uses for caustic soda; (2) it contacted caustic soda producers who were using the more expensive lime soda process and managed to sell caustic soda to some of them; and (3) it sought (with little success) to persuade users of other alkalis to substitute petitioner's caustic soda.
Among petitioner's additional captive uses for excess caustic soda in 1960 and 1961 were: (1) carbonating 18,350 tons in 1960 and 16,639 tons in 1961 for use as a replacement for soda ash for brine treatment (yielding petitioner the equivalent of $13 a ton for the caustic soda); (2) using 2,151 tons in 1960 and 1,860 tons in 1961 as a replacement for soda ash in making bicarbonate of soda (yielding petitioner the equivalent of $8 a ton for the caustic soda); (3) using 48 tons in 1960 and 54 tons in 1961 in petitioner's silicate furnace operation (yielding petitioner the equivalent of $8 a ton *65 for the caustic soda); (4) using 23,463 tons in 1960 and 29,537 tons in 1961 as a replacement for lime in petitioner's ammonia-soda operation (yielding petitioner the equivalent of $6.50 a ton for the caustic soda; and (5) neutralizing 684 tons in 1960 and 624 tons in 1961 with muriatic acid to form salt (resulting in a loss to petitioner of $2.50 a ton on the caustic soda). Petitioner disposed of a total of 52,148 tons of caustic soda in 1960 and a total of 53,550 tons of caustic soda in 1961 through additional captive use.
In 1960 and 1961 petitioner filled its caustic soda orders from its plants that had the greatest excess caustic soda, regardless of their distance from the customer. Petitioner absorbed the additional shipping costs. In 1960 petitioner contracted with a domestic chemical producer (which in 1960 planned to build a modern chlorine-caustic soda electrolytic plant) to sell liquid caustic at $25 a ton and eventually shipped them about 70,000 tons of caustic soda. At that time the domestic price for this type of caustic soda was $50 to $55 a ton. In 1960 and 1961, when the world markets were flooded with caustic soda, petitioner sold about 54,000 tons and about 56,000 *66 tons respectively of caustic soda in the export market.
During 1960 and 1961 petitioner disposed of a total of approximately 106,000 tons and 135,000 tons respectively of caustic soda out of its total caustic soda production of about 600,000 tons and 580,000 tons respectively.
In 1960 and 1961 petitioner realized net profit before taxes on sales of chlorine as follows: Year Net Profit Percentage of Net Sales
1960 $9,386,100 37.3 percent
1961 9,770,800 40.2
There is a recognized method of accounting for by-products. Generally, by-product accounting relates to products produced jointly with other products from common cost input factors and which are of minor economic value compared with the major products. Under the by-product accounting method no cost is assigned to the by-product up to the point at which it splits off from the other products. Only those costs incurred after the split off point, such as further processing, packaging or selling costs, are assigned to the by-product.
In computing the net sales of caustic soda to PPGI and the net commission export sales of caustic soda made by petitioner in 1960 and 1961, Jannis used petitioner's internal *67 financial statements. In computing the inventoriable cost of such sales, however, Jannis used a variation of the by-product method of accounting. In addition to charging the by-product for selling, general and administrative expenses, and production costs incurred after the split off point, Jannis also charged export caustic soda with certain period, research and development costs.
From petitioner's books and records Jannis obtained the following further processing costs for caustic soda: 1960 1961
Sales to PPGI $257,700 $325,600
Commission export sales 58,200 237,600
These costs were adopted by Jannis as the inventoriable costs of caustic soda in his computation of the pre-tax profit on petitioner's sales of caustic soda.
Under petitioner's normal accounting method, the joint costs of producing chlorine 1728 and caustic soda prior to the split off point were divided between the two products on the basis of atomic weight, 1.1 units of cost to caustic soda for each unit of cost to chlorine.
In 1960 87.3 percent ($5,738,000 $6,577,000) and in 1961 85.4 percent ($5,479,000 $6,417,000) of the sales made by petitioner's plate glass profit center to *68 PPGI were of primary plate. By contrast, in 1960 33.2 percent ($51,123,000 $153,895,000) and in 1961 38.4 percent ($44,631,000 $116,343,000) of the sales made by petitioner's plate glass profit center were of primary plate.
The products from petitioner's plate glass profit center consist of primary plate and fabricated plate. Fabricated plate consists of tempered, laminated and bent plate. The two elements in the cost of manufacturing fabricated plate are (1) the cost of manufacturing the raw plate and (2) the cost of fabricating the raw plate.
In his computation of the net profit of the plate glass profit center on export sales, Jannis allocated to export sales all of the plate glass profit center's primary and fabricated period costs on the basis of profit contribution, i. e., the ratio within the profit center of the profit contribution on sales to PPGI to the total profit contribution for the profit center. He apportioned the glass division's research expenses in 1960 and 1961 to export sales on the basis of profit contribution.
Columbia-Southern's actual research and development expenses for 1960 were $5,781,000 and petitioner's chemical division budgeted research and development *69 expenses for 1961 were $6,129,000. Jannis apportioned all of these expenditures to export sales on the basis of profit contribution. In the internal financial statements for petitioner's glass and chemical divisions depreciation is determined by reference to replacement cost rather than historical cost. Jannis allocated this replacement cost depreciation to net export sales on the basis of profit contribution.
Jannis allocated direct export office selling expenses of $126,000 in 1960 and $85,000 in 1961 to petitioner's net export sales of chemical products. He also apportioned the 1960 and 1961 advertising, general and administrative expenses of petitioner's chemical division to net export sales on the profit contribution basis.
Jannis allocated direct export selling expenses of approximately $126,000 in each of the years 1960 and 1961 to petitioner's net export sales of glass products. He also apportioned the 1960 and 1961 advertising, general and administrative expenses of petitioner's glass division to net export sales on the profit contribution basis.
Jannis based his computation of petitioner's net profit on sales to PPGI and on commission export sales on book net income *70 rather than taxable net income. Petitioner's book net income in 1960 for its glass, paint and brush, and fiber glass divisions was approximately $49,000,000 while its taxable income for that year was about $48,200,000. In 1961 petitioner's book net income from its glass, chemical, paint and brush, and fiber glass divisions was about $47,500,000 while its taxable income was approximately $46,700,000.
In determining PPGI's income for 1960 and 1961 Jannis worked principally from PPGI's general ledgers and from its trial balances. He determined the commissions petitioner paid to PPGI on export sales from contemporaneously prepared quarterly reports. Volume discounts granted to PPGI by petitioner were determined in part from PPGI's general ledger. In determining the portion of PPGI's 1960 selling, general and administrative expenses allocable to other income Jannis worked directly from PPGI's unaudited internal financial statements.
The determination of PPGI's net sales in 1960 and 1961 made by Jannis differs from the net sales shown in PPGI's audited and unaudited financial statements in that amounts for export freight equalization, outgoing transportation and duty, and cash discounts *71 have not been deducted from gross sales. Instead, these items were treated as selling expenses.
Jannis's determination of commissions allowed to PPGI by its affiliates in 1960 and 1961 differs from PPGI's financial statements in that Jannis's computation shows gross commissions paid by petitioner to PPGI. In 1960, some of these commissions had not been listed separately on PPGI's records but instead had been used as an offset against PPGI's cost of goods sold. In 1961 these commissions appeared as an offset to PPGI's selling and general expenses on its audited financial statements.
Jannis's determination of PPGI's selling, general and administrative expenses for 1960 and 1961 differs from PPGI's audited financial statements for 1960 and 1961 in that 1729 it has been reduced by amounts allocable to other income.
Jannis's determination of PPGI's selling, general and administrative expenses for 1961 differs from PPGI's audited and unaudited financial statements by disregarding the reduction of the bad debt reserve by the amount of $206,000 that appears in PPGI's financial statements.
In determining PPGI's income by product group Jannis allocated all expenses directly identified *72 with a specific product in the general ledger and trial balance of PPGI to that specific product, and he allocated all other expenses to the several products on the basis of profit contribution. Jannis did not accept the allocations of expenses appearing in the unaudited financial statements of PPGI for 1960 and 1961 which (unlike the audited financial statements of PPGI for those years) show net profit by product group.
Jannis computed petitioner's and PPGI's income in 1960 and 1961 on export sales of petitioner's products as follows: 1730 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1960
(In Thousends of Dollars)
Petitioner PPGI
Commissi Sales to Together Commission Sales to
on Sales PPGI Transactions Customers
Glass Division 1
Net sales and transfers $ 123 $ 7,811 $ 7,934 $ 123 $10,555
(after volume discount)
Inventoriable costs 66 5,162 5,228 123 8,186
Period costs, research and 29 1,304 1,333
engineering development
Selling and administrative 9 397 406 968
expenses
Commissions 6 6 (6)
110 6,863 6,973 117 9,154
Pre-tax profit (or loss) $ 13 $ 948 $ 961 $ 6 $ 1,401
Fiber Glass Division 1
C. & R. (Paint & Brush)
Division
Net sales and transfer $ 323 $ 467 $ 790 $ 323 $ 699
(after volume discount)
Inventoriable costs 205 359 564 323 530
Period costs, research and 33 30 63
engineering development
Selling and administrative 52 47 99 129
expenses
Commissions 8 8 (8)
298 436 734 315 659
Pre-tax profit (or loss) $ 25 $ 31 56 $ 8 $ 40
*73 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1960
(In Thousends of Dollars)
PPGI Eliminations On
Together Commission Intercompany Combined
Transactions Sales Total
Glass Division 1
Net sales and transfers $10,678 $ (123) $ (7,811) $10,678
(after volume discount)
Inventoriable costs 8,309 (123) (7,811) 5,603
Period costs, research and 1,333
engineering development
Selling and administrative 968 1,374
expenses
Commissions (6)
9,271 (123) (7,811) 8,310
Pre-tax profit (or loss) $ 1,407 , 2,368
Fiber Glass Division 1
C. & R. (Paint & Brush)
Division
Net sales and transfer $ 1,022 $ (323) $ (467) $ 1,022
(after volume discount)
Inventoriable costs 853 (323) (467) 627
Period costs, research and 63
engineering development
Selling and administrative 129 228
expenses
Commissions (8)
974 (323) (467) 918
Pre-tax profit (or loss) $ 48 $ 104
*74 1731 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1960
(In Thousands of Dollars)
Petitioner PPGI
Commissi Sales to Together Commission Sales to
on Sales PPGI Transactions Customers
Columbia-Southern Chemical
Corporation 2
Net sales and transfers $2,190 $ 3,558 $ 5,748 $2,190 $ 5,054
(after volume discount)
Inventoriable costs 712 1,817 2,529 2,190 3,976
Period costs, research and 774 898 1,672
engineering development
Selling and administrative 164 216 380 1,122
expenses
Commissions 74 74 (74)
1,724 2,931 4,655 2,116 5,098
Pre-tax profit (or loss) $ 466 $ 627 $ 1,093 $ 74 $ (44)
Total
Net sales and transfers $2,636 $11,836 $14,472 $2,636 $16,308
(after volume discount)
Inventoriable costs 983 7,338 8,321 2,636 12,692
Period costs, research and 836 2,232 3,068
engineering development
Selling and administrative 225 660 885 2,219
expenses
Commissions 88 88 (88)
2,132 10,230 12,362 2,548 14,911
Pre-tax profit (or loss) $ 504 $ 1,606 $ 2,110 $ 88 $ 1,397
Total pre-tax profit only
Percentage of net sales 14.6%
Split of combined total 58.7%
profit
*75 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1960
(In Thousands of Dollars)
PPGI Eliminations On
Together Commission Intercompany Combined
Transactions Sales Total
Columbia-Southern Chemical
Corporation 2
Net sales and transfers $ 7,244 [2,190) $ (3,558) $ 7,244
(after volume discount)
Inventoriable costs 6,166 (2,190) (3,558) 2,947
Period costs, research and 1,672
engineering development
Selling and administrative 1,122 1,502
expenses
Commissions (74)
7,214 (2,190) (3,558) 6,121
Pre-tax profit (or loss) $ 30 $ 1,123
Total
Net sales and transfers $18,944 [2,636) [11,836) $18,944
(after volume discount)
Inventoriable costs 15,328 (2,636) (11,836) 9,177
Period costs, research and 3,068
engineering development
Selling and administrative 2,219 3,104
expenses
Commissions (88)
17,459 (2,636) (11,836) 15,349
Pre-tax profit (or loss) $1,485 $ 3,595
Total pre-tax profit only
Percentage of net sales 7.8% 19.0%
Split of combined total 41.3% 100.0%
profit
*76
1732 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1961
(In Thousands of Dollars)
Petitioner PPGI
Commissi Sales to Together Commission Sales to
on Sales PPGI Transactions Customers
Glass Division
Net sales and transfers $ 67 $7,026 $ 7,093 $ 67 $ 9,386
(after volume discount)
Inventoriable costs 36 4,517 4,553 67 7,040
Period costs, research and 17 1,358 1,375
engineering development)
Selling and administrative 7 416 423 1,074
expenses
Commissions 1 1 (1)
61 6,291 6,352 66 8,114
Pre-tax profit (or loss) $ 6 $ 735 $ 741 $ 1 $ 1,272
Fiber Glass Division
Net sales and transfers $ 136 $ 85 $ 221 $ 136 $ 107
(after volume discount)
Inventoriable costs 83 61 144 136 94
Period costs, research and 57 26 83
engineering development
Selling and administrative 24 11 35 5
expenses
Commissions 3 3 (3)
167 98 265 133 99
Pre-tax profit (or loss) $ (31) $ (13) $ (44) $ 3 $ 8
C. & R. (Paint & Brush)
Division
Net sales and transfers $ 286 $ 496 $ 782 $ 286 $ 721
(after volume discount)
Inventoriable costs 179 353 532 286 550
Period costs, research and 32 42 74
engineering development
Selling and administrative 47 63 110 112
expenses
Commissions 24 24 (24)
282 458 740 262 662
Pre-tax profit (or loss) $ 4 $ 38 $ 42 $ 24 $ 59
*77 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1961
(In Thousands of Dollars)
PPGI Eliminations On
Together Commission Intercompany Combined
Transactions Sales Total
Glass Division
Net sales and transfers $ 9,453 $ (67) [7,026) $ 9,453
(after volume discount)
Inventoriable costs 7,107 (67) (7,026) 4,567
Period costs, research and 1,375
engineering development)
Selling and administrative 1,074 1,497
expenses
Commissions (1)
8,180 (67) (7,026) 7,439
Pre-tax profit (or loss) $ 1,273 $ 2,014
Fiber Glass Division
Net sales and transfers $ 243 $ (136) $ (85) $ 243
(after volume discount)
Inventoriable costs 230 (136) (85) 153
Period costs, research and 83
engineering development
Selling and administrative 5 40
expenses
Commissions (3)
232 (136) (85) 276
Pre-tax profit (or loss) $ 11 $ (33)
C. & R. (Paint & Brush)
Division
Net sales and transfers $ 1,007 $ (286) $ (496) $ 1,007
(after volume discount)
Inventoriable costs 836 (286) (496) 586
Period costs, research and 74
engineering development
Selling and administrative 112 222
expenses
Commissions (24)
924 (286) (496) 882
Pre-tax profit (or loss) $ 83 $ 125
*78 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1961
(In Thousands of Dollars)
Petitioner PPGI
Commissi Sales to Together Commission Sales to
on Sales PPGI Transactions Customers
Chemical Division
Net sales and transfers $1,726 $ 2,301 $ 4,027 $1,726 $ 3,239
(after volume discount)
Inventoriable costs 804 1,433 2,237 1,726 2,553
Period costs, research and 379 384 763
engineering development
Salling and administrative 98 109 207 879
expenses
Commissions 35 35 (35)
1,316 1,926 3,242 1,691 3,432
Pre-tax profit (or loss) $ 410 $ 375 $ 785 $ 35 $ (193)
Total
Net sales and transfers $2,215 $ 9,908 $12,123 $2,215 $13,453
(after volume discount)
Inventoriable costs 1,102 6,364 7,466 2,215 10,237
Period costs, research and 485 1,810 2,295
engineering development
Selling and administrative 176 599 775 2,070
expenses
Commissions 63 63 (63)
1,826 8,773 10,599 2,152 12,307
Pre-tax profit (or loss) $ 389 $ 1,135 $ 1,524 $ 63 $ 1,146
Total pre-tax profit only
Percentage of net sales 12.6%
Split of combined total 55.8%
profit
*79 Summary of "Pre-Tax Profit" to Petitioner on Sales To and Commission
Transactions with PPGI and To PPGI on Such Transactions and Sales to
Customers
CALENDAR YEAR 1961
(In Thousands of Dollars)
PPGI Eliminations On
Together Commission Intercompany Combined
Transactions Sales Total
Chemical Division
Net sales and transfers $ 4,965 [1,726) $ (2,301) $ 4,965
(after volume discount)
Inventoriable costs 4,279 (1,726) (2,301) 2,489
Period costs, research and 763
engineering development
Salling and administrative 879 1,086
expenses
Commissions (35)
5,123 (1,726) (2,301) 4,338
Pre-tax profit (or loss) $ (158) $ 627
Total
Net sales and transfers $15,668 [2,215) $ (9,908) $15,668
(after volume discount)
Inventoriable costs 12,452 (2,215) (9,908) 7,795
Period costs, research and 2,295
engineering development
Selling and administrative 2,070 2,845
expenses
Commissions (63)
14,459 (2,215) (9,908) 12,935
Pre-tax profit (or loss) $ 1,209 $ 2,733
Total pre-tax profit only
Percentage of net sales 7.7% 17.4%
Split of combined total 44.2% 100.0%
profit
*80 The following comparative ratios (expressed in terms of percentages) are based on the above computations for 1960 and 1961: Petitioner PPGI
1. Ratio of pre-tax
profit to
consolidated net
export sales.
1960 11.2 percent (2,110/18,944) 7.8 percent (1,485/18,944)
1961 9.7 percent (1,524/15,668) 7.7 percent (1,209/15,668)
2. Ratio of pre-tax
profit to
consolidated pre-tax
profit on net export
sales.
1960 58.7 percent (2,110/ 3,595) 41.3 percent (1,485/ 3,595)
1961 55.8 percent (1,524/ 2,733) 44.2 percent (1,209/ 2,733)
3. Ratio of pre-tax
profit to net export
sales.
1960 14.6 percent (2,110/14,472) 7.8 percent (1,485/18,944)
1961 12.6 percent (1,524/12,123) 7.7 percent (1,209/15,668)
Jannis computed PPGI's income (by division) for 1960 and 1961 as follows: Calendar Year Ended December 31, 1960
TOTAL For GLASS
Year
1960 CPI Duplate Other TOTAL
Gross Sales $16,336,062 $815,200 $6,391,247 $3,363,068
$10,569,515
Returns and 27,830 210 4,522 9,331 14,063
Allowances
Net Sales 16,308,232 814,990 6,386,725 3,353,737 10,555,452
Cost of Goods Sold 13,176,454 619,642 5,407,262 2,617,193 8,644,097
Less: Volume Discount 485,095 35,264 282,816 140,187 458,267
Net Cost of Goods 12,691,359 584,378 5,124,446 2,477,006 8,185,830
Sold
Gross Profit on Sales 3,616,873 230,612 1,262,279 876,731 2,369,622
Commissions Allowed 88,174 5,570 5,570
by Affiliates
Gross Income From 3,705,047 230,612 1,262,279 882,301 2,375,192
Selling
S.G. & A. Expenses:
Commissions Paid 381,175 191,366 191,366
Freight Equalization 110,969 8,939 77,666 1,075 87,680
Outgoing 809,708 24,681 708 55,191 80,580
Transportation and
Duty
Cash Discounts 95,797 1,618 60,771 27,960 90,349
Allowed
Employee Salaries and 567,234 34,797 190,508 132,323 357,628
Benefits
Employee Expenses 144,406 8,634 47,271 32,833 88,738
Bad Debts 6,304 4,131 4,131
Advertising 37,924 24,848 24,848
Professional Services 84,884 5,411 29,627 20,578 55,616
Telephone and 39,813 2,538 13,896 9,651 26,085
Telegraph
Other Deductions 181,105 11,546 63,210 43,904 118,660
Less: Apportioned to (240,100) (15,307) (83,801) (58,206) (157,314)
Tech. Sales
Total Sell., Gen. and 2,219,219 82,857 399,856 485,654 968,367
Admin. Exp.
Net Income From 1,485,828 147,755 862,423 396,647 1,406,825
Selling
Other Income:
Revenue From TKH 173,466
Commissions Earned 63,696
(Pittsburgh Corning)
Royalties 10,197
Interest and 44,587
Dividends
Profit on Sale of 165
Securities
Miscellaneous 16,045
Total Other Income 308,156
Other Expenses:
Amortization of TKH 623,466
Miscellaneous 329,728
Apportioned S.G. & A. 240,100
Expense
Total Other Expenses 1,193,294
Net Other Income and 885,138
Expenses
Net Income Before Tax $ 600,690
*81 Calendar Year Ended December 31, 1960
PAINT CHEMICAL
TOTAL Std. P.P.G.A., Other TOTAL
Chemical S.A.
Gross Sales $699,912 $883,799 $341,480 $3,841,356 $5,066,635
Returns and 616 13,151 13,151
Allowances
Net Sales 699,296 883,799 341,480 3,828,205 5,053,484
Cost of Goods Sold 557,148 836,967 249,562 2,888,680 3,975,209
Less: Volume Discount 26,828
Net Cost of Goods 530,320 836,967 249,562 2,888,680 3,975,209
Sold
Gross Profit on Sales 168,976 46,832 91,918 939,525 1,078,275
Commissions Allowed 8,470 74,134 74,134
by Affiliates
Gross Income From 177,446 46,832 91,918 1,013,659 1,152,409
Selling
S.G. & A. Expenses:
Commissions Paid 44,525 145,284 145,284
Freight Equalization 23,289 23,289
Outgoing 1,259 727,869 727,869
Transportation and
Duty
Cash Discounts 4,154 1,294 1,294
Allowed
Employee Salaries and 57,066 6,620 12,996 132,924 152,540
Benefits
Employee Expenses 16,942 1,681 3,299 33,746 38,726
Bad Debts 294 1,879 1,879
Advertising 1,771 11,305 11,305
Professional Services 3,964 1,098 2,156 22,050 25,304
Telephone and 1,859 515 1,011 10,343 11,869
Telegraph
Other Deductions 8,458 2,343 4,600 47,044 53,987
Less: Apportioned to (11,213) (3,106) (6,098) (62,369) (71,573)
Tech. Sales
Total Sell., Gen. and 129,079 32,440 17,964 1,071,369 1,121,773
Admin. Exp.
Net Income From $ 48,367 $ 14,392 $ 73,954 $ (57,710) $ 30,636
Selling
*82 Calendar Year Ended December 31, 1961
TOTAL For GLASS
Year
1961 CPI Duplate Other TOTAL
Gross Sales $13,910,856 $1,389,874 $5,420,239 $2,788,013 $9,598,126
Returns and 458,262 54,165 124,439 33,512 212,116
Allowances
Net Sales 13,452,594 1,335,709 5,295,800 2,754,501 9,386,010
Cost of Goods Sold 10,691,613 959,434 4,327,242 2,173,461 7,460,137
Less: Volume 454,812 49,060 250,385 120,514 419,959
Discount
Net Cost of Goods 10,236,801 910,374 4,076,857 2,052,947 7,040,178
Sold
Gross Profit on 3,215,793 425,335 1,218,943 701,554 2,345,832
Sales
Commissions 62,517 1,313 1,313
Allowable by
Affilistes
Gross Income From 3,278,310 425,335 1,218,943 702,867 2,347,145
Selling
S.G. & A. Expenses:
Commissions Paid 277,679 158,998 158,998
Freight Equalization 50,213 2,867 38,442 18 41,327
Outgoing 1,019,228 127,243 127,668 107,744 362,655
Transportation and
Duty
Cash Discounts 86,160 54,099 22,567 76,666
Allowed
Employee Salaries 468,203 61,863 177,730 102,195 341,788
and Benefits
Employee Expenses 115,634 14,694 42,214 24,272 81,180
Bad Debts 15,675 7,276 7,276
Advertising 41,910 10,630 10,630
Professional 42,406 5,603 16,097 9,256 30,956
Services
Telephone and 57,481 7,186 20,647 11,872 39,705
Telegraph
Other Deductions 121,389 16,039 46,079 26,496 88,614
Less: Apportioned to (226,594) (29,940) (86,015) (49,459) (165,414)
Tech. Sales
Total Sell., Gen. 2,069,384 205,555 436,961 431,865 1,074,381
and Admin. Exp.
Net Income From 1,208,926 219,780 781,982 271,002 1,272,764
Selling
Other Income:
Commissions Earned 96,182
(Pittsburgh Corning)
Royalties 37,248
Interest and 113,444
Dividends
Profit on Sale of 423,866
Securities
Miscellaneous 74,890
Total Other Income 926,874
Other Expenses:
Amortization of TKH 604,268
Misc. Cuban Office 66,074
Expense
Miscellaneous 39,438
Reversal of Bad Debt (206,004)
Expense(1959)
Apportioned S.G. & 226,594
A. Expense
Total Other Expenses 730,370
Net Other Income and 196,504
Expenses
Net Income Before $ 1,405,430
Tax
*83 Calendar Year Ended December 31, 1961
CHEMICAL
FIBERGLASS PAINT Std.
Other Other Chemical
Gross Sales $107,016 $725,338 $543,685
Returns and Allowances 68 4,766
Net Sales 106,948 720,572 543,685
Cost of Goods Sold 100,000 578,624 480,138
Less: Volume Discount 5,755 29,098
Net Cost of Goods Sold 94,245 549,526 480,138
Gross Profit on Sales 12,703 171,046 63,547
Commissions Allowable by Affiliates 2,750 23,945
Gross Income From Selling 15,453 194,991 63,547
S.G. & A. Expenses:
Commissions Paid 2,000 36,100
Freight Equalization 8,886
Outgoing Transportation and Duty 953 483
Cash Discounts Allowed 204 3,942 5,081
Employee Salaries and Benefits 1,873 24,815 7,679
Employee Expenses 236 13,524 1,594
Bad Debts 2,084
Advertising 31,089
Professional Services 170 2,248 695
Telephone and Telegraph 34 2,643 1,162
Other Deductions 485 6,434 1,991
Less: Apportioned to Tech. Sales (906) (12,009) (3,716)
Total Sell., Gen. and Admin. Exp. 4,096 111,823 23,855
Net Income From Selling $ 11,357 $ 83,168 $ 39,692
Calendar Year Ended December 31, 1961
CHEMICAL
P.P.G.A.,
S.A. Other TOTAL
Gross Sales $ 316,119 $2,620,572 $3,480,376
Returns and Allowances 275,000 16,312 210,312
Net Sales 91,119 2,604,260,h
3,239,064
Cost of Goods Sold 227,425 1,845,289 2,552,852
Less: Volume Discount
Net Cost of Goods Sold 227,425 1,845,289 2,552,852
Gross Profit on Sales (136,306) 758,971 686,212
Commissions Allowable by Affiliates 34,509 34,509
Gross Income From Selling (136,306) 793,480 720,721
S.G. & A. Expenses:
Commissions Paid 80,581 80,581
Freight Equalization 8,886
Outgoing Transportation and Duty 126,415 528,722 655,620
Cash Discounts Allowed 267 5,348
Employee Salaries and Benefits 92,048 99,727
Employee Expenses 19,100 20,694
Bad Debts 6,315 6,315
Advertising 191 191
Professional Services 8,337 9,032
Telephone and Telegraph 13,937 15,099
Other Deductions 23,865 25,856
Less: Apportioned to Tech. Sales (44,549) (48,265)
Total Sell., Gen. and Admin. Exp. 126,415 728,814 879,084
Net Income From Selling [262,721) $ 64,666 $ (158,363)
*84 1738
A schedule prepared by the controller's office of petitioner's glass division covering the first nine months of 1959 shows a net income of $380,335 earned by petitioner on sales of glass products to PPGI in the amount of $5,036,138. The schedule was prepared by using a seven month average of standard variable costs of products and multiplying this figure by the units sold. Period, research, selling, general and administrative costs were then added to the variable cost figure. To determine these additional costs, the variable cost was multiplied by a percentage figure. The schedule shows that for a large group of glass products sold by petitioner to PPGI these additional costs averaged 58.9 percent of the variable costs.
The internal financial statement of PPGI covering a 13-month period ending December 31, 1960 shows net income from the sale of glass products, paint products and chemicals as follows: (In Thousands)
Total Glass Paint Chemicals
Gross Sales $17,793.9 11,597.0 $745.8 $5,451.0
Less: Ret. & All. 30.8 17.0 .6 13.1
Freight Equalization 113.2 89.9 23.2
Outgoing Transport. 873.2 85.7 1.3 786.1
Cash Discounts Allowed 103.5 97.7 4.3 1.3
Total Sales Deductions 1,120.8 290.5 6.3 823.9
Net Sales 16,673.0 11,306.5 739.4 4,627.0
Cost of Sales 14,324.6 9,463.1 594.7 4,266.7
Gross Income before
Volume Discount 2,348.4 1,843.4 144.6 360.3
Volume Discount 541.1 512.1 29.0
Gross Income after
Volume Discount 2,889.5 2,355.5 173.6 360.3
Percent of Net Sales
Before Volume Discount 14.1% 16.3% 19.6 7.8%
After Volume Discount 17.3% 20.8% 23.5% 7.8%
Selling and Adm. Expenses
Selling * 867.7 427.4 185.0 356.0
Aministrative 564.1 219.4 16.7 139.5
Incentive Compens. 59.5
Apportioned to Tech. Services (273.6)
Net Expenses 1,217.7 646.8 201.8 495.6
Net Income from Sales 1,671.8 1,708.6 (28.1) (135.3)
Percent of Net Sales 10.0% 15.1% (3.8%) (2.9%)
*85
The internal financial statements of PPGI indicate net income from the sale of glass products, paint products and chemicals for the month of December, 1959 as follows: (In Thousands)
Total Glass Paint Chemicals
Gross Sales $1,457.9 $1,027.6 $45.9 $384.4
Less: Ret. & All., Freight, etc. 76.6 18.0 .3 58.3
Net Sales 1,381.3 1,009.6 45.6 326.1
Cost of Sales 1,153.0 823.9 37.6 291.5
Gross Income before Volume Discount 228.3 185.7 8.0 34.6
Volume Discount 56.0 53.8 2.2
Gross Income after Volume Discount 284.3 239.5 10.2 34.6
Sell. & Adm. Exp. 100.1 66.8 4.0 29.3
Net Income $ 184.2 $ 172.7 $ 6.2 $ 5.3
1739
For the 12-month period ending December 31, 1960 the net sales, gross profits and net profits of PPGI, as shown by its internal financial statements, are as follows: (In Thousands)
Total Glass Paint Chemicals
Net Sales $15,291.6 $10,296.3 $693.8 $4,300.9
Cost of Sales 13,171.5 8,639.2 557.1 3,975.2
Gross Income before
Volume Discount 2,120.1 1,657.1 136.7 325.7
Volume Discount 485.1 458.3 26.8 --
Gross Income after $ 2,605.2 $ 2,116.0 $163.5 $ 325.7
Volume Discount
*86 (In Thousands)
Glass Paint Chemicals
Net Profit - 13 month period ending 12/31/60 $1,708.6 $ (28.1) $ (135.3)
Net Profit - month of Dec. 1959 172.7 6.2 5.3
Net Profit - 12 month period ending 12/31/60 $1,535.9 $ (21.9) $ (130.0)
In 1960 PPGI received commissions in the amount of $63,700 from sales of Pittsburgh Corning products which were not included in income in the preceding schedules for 1960. However, the expenses incurred in earning such commissions were included in the preceding schedules for 1960.
The internal financial statement of PPGI for the year ending December 31, 1961 shows net income from the sale of glass products, paint products and chemicals as follows: (In Thousands)
Total Glass Fiberglass Paint Chemicals
Net Sales $12,297 $8,905 $107 $716 $2,569
Cost of Sales 10,692 7,460 100 579 2,553
Gross Income 1,605 1,445 7 137 16
Percent of Sales 13.1% 16.2% 6.6% 19.1% .6%
Volume Discount 455 420 6 29
Gross Income after
Volume Discount 2,060 1,865 13 166 16
Percent of Sales 16.8% 20.9% 11.6% 23.2% .6%
Commissions 159 131 3 25
Total Gross Income 2,219 1,996 13 169 41
Selling Expenses 708 445 2 121 140
Net Income from
Sales * $1,511 $1,551 $ 11 $ 47 $ (99)
*87
The internal financial statements of PPGI show gross income from sales of petitioner's glass products to CPI, Duplate and other customers during the years ended December 31, 1960 and 1961 as follows: 1960 (In Thousands)
Total CPI Duplate Other
Net Sales $10,296.9 $779.7 $6,247.6 $3,265.5
Cost of Sales 8,639.2 619.5 5,407.2 2,612.3
Gross Income before Volume Discount 1,657.7 160.2 840.4 657.2
Volume Discount 458.13 35.2 282.8 140.2
Gross Income after
Volume Discount 458.13 35.2 282.8 140.2
Percent of Net Sales after Volume 20.5% 25.1% 18.0% 24.4%
Dis.
1961 (In Thousands)
Total CPI Duplate Other
Net Sales $ 8,905 $1,206 $5,075 $2,624
Cost of Sales 7,460 960 4,357 2,173
Gross Income before Volume Discount 1,445 246 748 451
Volume Discount 420 49 250 121
Gross Income after Volume Discount $ 1,865 $ 295 $ 998 $ 572
Percent of Net Sales after Volume 20.9% 24.5% 19.7% 21.8%
Dis.
The internal financial statements of petitioner's paint and brush division show that it sustained *88 a loss of $24,300 on net sales of paint products to PPGI during the year 1960 in the amount of $496,400. In the computation of such loss none of the research, development and advertising costs were allocated to the products sold to PPGI. Moreover, the loss of $24,300 in the year 1960 was computed before the allowance of the volume discount under the agreement between petitioner and PPGI.
The internal financial statements of petitioner's paint and brush division reflected the following net income on its net sales of paint products to PPGI: $42,000 (actual) on net sales of $579,000 in 1959 and $69,000 (forecast) on net sales of $670,000 (forecast) in 1961.
A summary of PPGI's balance sheet as of December 31, 1960 (covering a 13-month period ending on 12/30/60) and December 31, 1961 as it appears in the audited financial statements is as follows: PPGI Balance Sheet, December 31, 1960
Assets
Current Assets
Cash $ 214,291.32
Funds available to wholly-owned subsidiary 229,000.00
Accounts Receivable 4,216,657.05
Notes Receivable 419,500.00
Merchandise (at cost) shipped to customers but not billed 102,575.70
Total current assets 5,182,024.07
Non-current accounts receivable 56,366.04
Investments 3,079,880.72
Rights to technical data and know-how (at cost, less 1,906,530.00
accumulated amortization)
Property - at cost, less accumulated depreciation 346,829.28
(machinery and equipment; furn. and fix.)
Deferred charges other assets 193,511.44
$10,765,141.55
Liabilities and equity
Current Liabilities
Notes Payable $ 506,037.27
Accounts Payable 2,490,114.09
Accrued Taxes 51,292.79
Total current liabilities 3,047,444.15
Non-current accounts payable 2,200,000.00
Deferred Income 482,166.86
Stockholders' equity 5,035,530.54
Total $10,765,141.55
*89 PPGI Balance Sheet, December 31, 1961
Assets
Current Assets
Cash $ 2,209,745.47
Accounts Receivable 3,239,869.64
Notes Receivable 834,750.00
Finished goods (cost) 57,494.27
Merchandise (cost) - shipped to customers but not billed 59,947.70
Total current assets $ 6,401,807.08
Non-current accounts receivable 87,727.79
Investments 3,956,086.19
Rights to technical data and know-how (cost less 4,802,262.00
accumulated amortization)
Property (cost less depreciation) 59,369.84
Deferred and other charges 47,250.53
$15,354,503.43
Liabilities and equity
Current Liabilities
Notes Payable $ 311,389.96
Accounts Payable 2,981,592.44
Accrued Taxes 52,888.76
Total current liabilities $ 3,345,871.16
Non-current accounts payable 5,997,560.10
Deferred Income 539,127.20
Stockholders' Equity 5,471,944.97
Total $15,354,503.43
A combination export manager (hereinafter called CEM) engages in the business of handling the exports of more than one domestic manufacturer. A CEM generally performs two functions: (1) the export mechanics, i.e., paper work, necessary in the export of various products and (2) a limited selling function by selecting *90 and dealing through foreign commission agents and distributors to fill a prevailing demand for a particular product. A CEM generally does not perform a marketing function in that it does not attempt to develop new markets, does not decide price policies in foreign markets, and does not sell at a loss to gain a foothold in new markets. In general, a CEM is an intermediary between a domestic manufacturer and foreign sales agents and distributors.
There are approximately 5,000 manufacturers in the United States who are represented in foreign markets by combination export managers. The total annual volume of export sales handled by combination export managers is approximately $500,000,000. There are from 500 to 600 combination export managers in the United States, with most of them concentrated in New York City, Philadelphia, Baltimore, Chicago, San Francisco and Los Angeles.
A CEM will operate in nearly all foreign markets except those in the eastern bloc countries and in the underdeveloped countries (such as the African republics). A CEM does not operate in countries where the manufacturers themselves handle their exports, such as Puerto Rico, Canada and, in some cases, Mexico, where *91 the manufacturers do not require the services of a CEM. Omni Products, the largest CEM in the United States, has never made a sale in the Canadian market.
A CEM employs salesmen who travel outside the United States and also employs a complement of clerical employees to 1743 prepare export documents, invoices and shipping documents. A freight forwarder may at times be used by a CEM to prepare bills of lading, export declarations and dock receipts.
A function performed by a CEM is the determination of the credit standing of foreign customers through indirect means, i. e., banks, inspection of the customers' plants, and inquiries made of various trade sources. A CEM performs another function by providing foreign customers with a broad line of products at a dependable price.
When a CEM takes on a new product it will spend some time in the manufacturer's laboratory and sales department to become acquainted with the product and if necessary would employ someone familiar with the technical nature of the product. However, the sales approach and the functions of a CEM are substantially the same for all products.
A CEM is limited in the extent to which it can adjust prices in a *92 foreign market. It can adjust prices only within the framework of the discount granted to the CEM by the domestic manufacturer. A CEM obtains a combined discount of from 8 1/2% to 25% from the manufacturers' domestic prices and in turn pays commissions of from 3% to 10% to its foreign distributors and agents.
A CEM may act as a merchant exporter, i. e., it gets title to the products it receives from the domestic manufacturer and thus incurs some credit risks when it sells the products. A CEM who acts as principal may determine the mark-up in foreign markets and invoices its customers under its own name. It does not maintain an inventory. Instead, all goods are shipped from the factories and warehouses of the manufacturer.
A CEM may also act an an agent, in which case the CEM is paid a commission only after the purchaser makes payment to the manufacturer. By the nature of its operation a CEM is generally limited in its ability to extend credit.
A CEM usually makes only limited market studies. It does not advertise extensively but will generally translate existing advertising and promotional literature for the foreign market.
Generally, a CEM earns a net profit before tax of *93 from two percent to five percent of sales. A few CEMs that perform broader functions than the usual CEM, such as licensing and direct marketing activities, earn a net profit before tax of from 5 percent to 15 percent of sales. Typically, the income of a CEM as a percentage of invested capital ranges from 30 percent to 70 percent.
When its exports exceed anywhere from $200,000 to $600,000 a domestic manufacturer will generally terminate its use of a CEM and will establish its own export department. Many large manufacturers have progressed from export departments to international divisions or subsidiaries. Large manufacturers use a CEM only for products unrelated to their main line of products and involve only a small volume of sales.
International subsidiaries are distinguishable from CEMs in that they perform certain functions, including the following, which are not normally performed by a CEM: (1) management responsibility for all foreign operations; (2) coordination of foreign marketing; (3) in depth market studies; (4) extension of credit as a marketing tool; (5) warehouse operations; (6) significant post-sales services to customers; (7) holding equity investments in foreign *94 subsidiaries; (8) manufacturing operations in foreign countries; (9) licensing patents, trademarks and know-how; and (10) providing technical services to foreign subsidiaries and licensees.
In the statutory notice of deficiency (dated July 28, 1966) respondent determined that pursuant to the provisions of section 482 of the 1954 Internal Revenue Code it was necessary to allocate gross income in the amounts of $1,032,999 and $866,749 from PPGI to petitioner in the years 1960 and 1961, respectively. The determination was based upon the adjustments recommended by William F. English, a revenue agent with the Office of International Operations. He based the adjustments on the United States Treasury Department's "Source Book of Statistics of Income" for 1960 and 1961.
The basic approach in the Statistics of Income is that the organizations or companies filing Federal income tax returns are grouped into major and minor industry classifications. Within each classification the companies are grouped into size categories based upon the amounts of their assets. The classifications of the data in the Statistics of Income is derived from the 1744 Standard Industrial Classification Manual *95 used by the Department of Commerce and the Bureau of the Budget for classifying industries. The actual statistics used by the revenue agent were under the heading: "Returns with Net Income-Wholesale and Retail Trade: Wholesale Trade: Other Wholesalers: Drugs, Chemicals, and Allied Products-Minor Industry 493."
The Standard Industrial Classification Manual describes the companies constituting the manual's Group 502 ("Other Wholesalers: Drugs, Chemicals and Allied Products") as follows:
Drugs, drug proprietaries, and druggists' sundries
Establishments primarily engaged in the wholesale distribution of drugs, drug proprietaries, druggists' sundries, and toiletries. Establishments primarily engaged in the wholesale distribution of surgical, dental, and hospital equipment are classified in Industry 5086.
Paints and varnishes
Establishments primarily engaged in the wholesale distribution of paints and varnishes in paste or powder form or ready for use. Glass and wallpaper are frequently handled.
Chemicals and allied products, not elsewhere classified
Establishments primarily engaged in the wholesale distribution of chemicals and allied products, not elsewhere classified, such *96 as acids, ammonia, industrial and heavy chemicals, dyestuffs, industrial salts, insecticides, naval stores, plastics materials, rosin, and turpentine. Establishments primarily engaged in the wholesale distribution of ammunition and fireworks are classified in Industry 5099.
The revenue agent computed the 1960 and 1961 income allocable from PPGI to petitioner as follows: (1) On the basis of PPGI's balance sheets as of December 31, 1960 and 1961 he placed PPGI within the category of the ten corporations in 1960 and the eight corporations in 1961 that comprised the group under the above-mentioned heading in the statistics source book with total assets from $10,000,000 to $25,000,000. (2) He then determined the 1960 and 1961 ratios of net profit before tax to business receipts of such group of corporations as follows:
(3) The revenue agent applied these percentages to the amounts treated by him as gross sales of PPGI for 1960 and 1961 ($17,793,900 X.0359 for the year 1960 and $12,989,900 X.0243 for the year 1961) and thus determined the profit which he deemed appropriate for those years, i. e., $638,801 for 1960 and $315,632 for 1961. (4) The revenue agent then determined the income *97 allocable to petitioner under section 482 of the 1954 Internal Revenue Code by subtracting the amount of $638,801 from $1,671,800 (the purported earnings of PPGI) in 1960 and the amount of $315,632 from $1,182,381 (the purported earnings of PPGI) in 1961, i. e., $1,032,999 in 1960 and $866,749 in 1961.
The amounts used in the above computations by the revenue agent as gross sales of PPGI in 1960 and 1961 did not include PPGI's commission sales on behalf of petitioner and PPGI's commission sales on behalf of Pittsburgh Corning.
On May 13, 1968, after both parties had presented their evidence on the Section 482 issue, respondent filed a motion to amend his answer to conform the pleadings to the proof. This Court granted the motion and in respondent's second amendment to his answer he alleged that additional allocations of PPGI's income to petitioner should be made in the amounts of $437,501 in 1960 and $623,451 in 1961 pursuant to the provisions of section 482 of the 1954 Internal Revenue Code , or total income allocated from PPGI to petitioner in the amounts of $1,470,490 ($1,032,999 plus $437,501) in 1960 and $1,490,200 ($866,749 plus $623,451) in 1961. Consequently, respondent *98 claimed additional deficiencies in petitioner's income tax of $227,500 in 1960 and $324,194 in 1961. Respondent alleged in his second amendment to his answer that (1) all of PPGI's income on sales to petitioner's Canadian subsidiaries (Duplate and CPI) was actually earned by petitioner and CPI) was actually earned by petitioner nad percent (a percentage derived from the testimony of the combination export managers) on its sales to unrelated customers.
During the period 1958 to 1961 petitioner entered into three separate agreements whereby it transferred the foreign rights in certain technology to PPGI. Petitioner had 1745 accumulated such technology over the years with respect to its paint and coating products, its Duracron and Duracryl products and its all glass Twindow products. In 1958 and 1959 Columbia-Southern entered into two separate agreements whereby it transferred to PPGI the foreign rights to certain technology involving chemical processes.
Petitioner and Columbia-Southern did not develop paint, glass or chemical technology for sale to customers. All of their research and development programs were directed toward the creation of new products and the improvement *99 of existing products. Excluding the agreements with PPGI, petitioner made one other sale of technology during the period from 1944 to 1961.
When petitioner and Columbia-Southern obtained United States patents for their paint, glass or chemical technology, they often filed foreign patent applications to protect their discoveries against foreign appropriation by others who might thereby compete with the petitioner in domestic and foreign markets. Other reasons for seeking foreign patents were (1) the prospect of selling such foreign patents and (2) the prospect of licensing such patents.
On November 17, 1958 petitioner and PPGI entered into an agreement relating to petitioner's paint and coating technology. Petitioner agreed to transfer to PPGI the "technical data now in [petitioner's] possession" relating to paint and coating products. Petitioner and PPGI each agreed to transfer to the other "technical data hereafter coming into its possession during the term of this Agreement" relating to paint and coating products. Section 7 of the agreement provided that "[this] Agreement shall terminate within five (5) years from the date hereof," but under certain circumstances the agreement *100 could be extended for additional periods not to exceed 10 years. Upon termination of the agreement none of the paint and coating technology transferred to PPGI would revert to petitioner.
Under the November 17, 1958 agreement petitioner granted PPGI "an irrevocable, royalty-free, transferable, exclusive right to use in the Benelux [countries] and France for the manufacture of paint and coating products the technical data not covered by patents * * * with the right in [PPGI] to transfer or disclose and to sublicense such technical data to others for like use in

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4624802. Public record. Not legal advice.