# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

T.C. Memo. 1996-57

UNITED STATES TAX COURT

BAUSCH & LOMB INCORPORATED AND CONSOLIDATED
SUBSIDIARIES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 13983-91, 1215-92.

Filed February 15, 1996.

Dennis I. Meyer, C. David Swenson, A. Duane Webber, Diane S.
Rohleder, J. Michael Cornett, and John W. Polk, for petitioners.
Matthew J. Fritz, Jeffrey L. Bassin, Nancy Ortmeyer Kuhn,
and Judith Cavell Cohen, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION
CHIECHI, Judge:

Respondent determined the following defi-

ciencies in petitioners' Federal income tax:
Taxable Year Ended

Deficiency

Dec. 25, 1983
Dec. 30, 1984

$9,340,688
14,947,579

- 2 Dec. 29, 1985
5,417,150
Dec. 28, 1986
6,529,257
Dec. 27, 1987
5,339,670
The following issues remain for decision:1
(1)

Does the income for each of the years at issue from the

sale of sunglasses assembled2 by Bausch & Lomb Ireland, Ltd. (B&L
Ireland) and by Bausch & Lomb Hong Kong, Ltd. (B&L Hong Kong)
constitute foreign base company sales income as defined in
section 954(d)(1) that is includible in petitioners' gross income
under section 951(a)(1)?
(2)

We hold that it does not.

Did respondent abuse her discretion under section

954(b)(4) by failing to exclude certain income of B&L Hong Kong
from sources other than the sale of sunglasses it assembled3 from
petitioners' gross income for their taxable years

1

Prior to the trial herein, the Court granted the parties'
joint motion to sever a capital loss carryback issue relating to,
inter alia, petitioners' taxable year ended Dec. 27, 1987. Since
that year is one of the years at issue in docket No. 1215-92, no
decision may be entered in that case at the present time.
2

Unless otherwise indicated, our use herein of the words "assembled", "produced", "manufactured", and similar words does not
reflect the Court's view as to whether the sunglasses assembled
by Bausch & Lomb Ireland, Ltd. and by Bausch & Lomb Hong Kong,
Ltd. were manufactured by each of those companies for purposes of
sec. 954(d)(1).
All section references are to the Internal Revenue Code (Code)
in effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
3

Not all of B&L Hong Kong's income from sources other than the
sale of sunglasses it assembled is at issue herein. See discussion infra.

- 3 endedDecember25, 1983, through December 28, 1986?4

We hold that

she did not.
FINDINGS OF FACT5

4

In light of our holding on issue (1), we need not, and shall
not, address petitioners' contention that B&L Hong Kong's income
from the sale of sunglasses it assembled is excludible from
petitioners' gross income for each of those years under sec.
954(b)(4).
5

At the conclusion of the trial herein, the Court ordered the
parties to file seriatim briefs and limited the parties' respective briefs to a total of 150 pages, including the proposed
findings of fact. Petitioners' opening and reply briefs totaled
exactly 150 pages. It appears that they were able to so limit
their briefs only by violating Rule 151(e)(3). That Rule
requires the opening briefs of the parties to contain:
Proposed findings of fact * * * based on the evidence, in
the form of numbered statements, each of which shall be
complete and shall consist of a concise statement of essential fact and not a recital of testimony nor a discussion
or argument relating to the evidence or the law. * * *
Petitioners' opening brief did not contain any "Proposed findings
of fact * * * in the form of numbered statements" with respect to
any facts to which the parties stipulated in the revised first
stipulation of facts (first stipulation) and to which neither
party objected on evidentiary grounds. Respondent objected in
her brief to petitioners' failure to propose such stipulated
facts and their resultant violation of Rule 151(e)(3). However,
respondent did not request the Court to impose sanctions on
petitioners.
During the pretrial and trial phases of these cases, petitioners' lead counsel made it known to the Court on a number of
occasions that he is no stranger to this Court, since he has
appeared before us as attorney of record in a number of different
cases. We therefore presume that he is, and in any event he and
all counsel who appear before us should be, thoroughly familiar
with this Court's Rules, including Rule 151(e)(3). Since respondent did not seek any sanctions from the Court for petitioners'
failure to comply with Rule 151(e)(3), which we view as nothing
more than their attempt to circumvent the page limitation we
(continued...)

- 4 -

Some of the facts have been stipulated and are so found.6
Bausch & Lomb Incorporated (B&L Inc.) is a corporation
organized under the laws of the State of New York.

At the time

the petitions were filed, its principal corporate offices were
located in Rochester, New York (Rochester).

B&L Inc. and certain

of its subsidiaries filed consolidated Federal income tax returns
(Forms 1120) for the taxable years ended December 25, 1983,
December 30, 1984, December 29, 1985, December 28, 1986, and
December 27, 1987.
For each of the years at issue,7 petitioners kept their
books and records and filed their Federal income tax returns on
the accrual method of accounting using a 52-53 week taxable year.
B&L Inc. was a U.S. shareholder of B&L Ireland and of B&L Hong
Kong within the meaning of section 951(b), B&L Ireland and B&L
Hong Kong were controlled foreign corporations (CFCs) of peti-

5

(...continued)
placed on the briefs in these cases, we shall impose no sanctions
at this time. However, we caution petitioners and their counsel
that any further violations of our Rules and Orders will be met
with the imposition of appropriate sanctions, regardless whether
respondent makes a request for sanctions.
6

Each party objected to certain stipulations in the first
stipulation, the second stipulation of facts, and the third
stipulation of facts. (Those stipulations will be referred to
collectively as the stipulations of facts.) We address those
objections below.
7

Unless otherwise indicated, our Findings of Fact and Opinion
herein relate to the years at issue.

- 5 tioners within the meaning of section 957(a), and B&L Ireland and
B&L Hong Kong maintained their books and records on the accrual
method of accounting using a 52-53 week taxable year.
B&L Inc. and Subsidiaries8
B&L traces its roots to an optical shop located in Rochester
that was founded in 1853 by John J. Bausch and Henry Lomb.

Prior

to World War I, B&L became the first producer in the United
States of optical quality glass, a vital material for military
instruments, that freed the United States from its dependence on
European sources of such glass.
Prior to and during the years at issue, B&L manufactured and
sold a wide range of optical-related products, including contact
lenses, contact lens solutions, sunglasses,9 binoculars, telescopes, and scientific instruments (e.g., microscopes).10

Prior

to the years at issue, B&L manufactured and sold prescription
eyeglasses.

Prescription eyeglasses are a separate and distinct

product from noncorrective sunglasses.

Prescription eyeglasses

contain individually finished, corrective lenses, are tailored

8

Hereinafter, we shall refer to B&L Inc. and all of its subsidiaries, not just those subsidiaries that were consolidated for
Federal income tax purposes, as B&L.
9

As used herein, the term "sunglasses" means sunglasses with
noncorrective lenses.
10

B&L was also involved in certain biomedical fields. However,
that segment of its business is not relevant to the issues
presented in these cases.

- 6 for a specific prescription and to fit an individual face, and
are assembled by retail optical shops.

In contrast, sunglasses

have noncorrective lenses, are tailored to fit a standard face,
and are assembled prior to reaching the retailers.

B&L discon-

tinued its prescription eyeglasses product line during 1981.

As

of 1987, B&L performed manufacturing or marketing operations in
25 countries and its products were distributed in over 70 countries.
B&L began manufacturing and selling soft contact lenses
during 1971.

Prior to 1980, B&L's only manufacturing facility

that had the ability to produce soft contact lenses using the
spin cast process was located in Rochester (Rochester facility).
B&L determined that it was prudent to establish additional soft
contact lens manufacturing capacity overseas in order to minimize
regulatory delays, establish an alternative supply source to the
Rochester facility, and have a facility capable of more efficiently serving the increasingly important European markets.
Because of incentives, including tax benefits, offered by the
Government of the Republic of Ireland (Ireland) to induce companies to establish manufacturing facilities in Ireland, it was
determined that B&L could realize those objectives most cost
effectively in Ireland.

Accordingly, for valid business reasons,

on February 1, 1980, B&L Ireland was incorporated under the laws
of Ireland to manufacture contact lenses.

B&L Ireland's contact

- 7 lens manufacturing facility was located in an industrial estate
in Waterford, Ireland (Waterford industrial estate).
During the 1970s and the 1980s, B&L was increasingly turning
its attention to international markets, including Southeast Asia
where B&L was experiencing rapid growth in the sale of its
products.

Prior to 1972, B&L distributed its sunglasses and

other products in certain Southeast Asian markets through independent distributors unrelated to B&L (independent distributors) that sold products other than B&L products, including in
the case of at least one such distributor sunglasses produced by
a competitor of B&L.

The independent distributors did not focus

on B&L products, and B&L maintained no direct contact with the
retail optical shops in Southeast Asia that sold its sunglasses
to consumers.

In addition, B&L did not maintain any inventory in

Southeast Asia and experienced long lead times on product orders
originating in that market due to a delay in shipping products
from the United States to that part of the world.

This was the

case even though during the early 1970s B&L was experiencing
rapid sales growth in Southeast Asia as that market began to
develop and its consumers could afford more luxury-type products.
In 1971, B&L opened an office in Hong Kong, its largest
market in Southeast Asia.

Although that office, which it called

a representative office, acted as a liaison between B&L and its
independent distributors, it did not maintain any inventory or

- 8 employ its own sales force.

In order to improve customer service

and reduce the lead time on product orders, the director of the
representative office in Hong Kong suggested to the Ophthalmic
Division of B&L Inc.11 in Rochester that B&L operate a warehouse
to maintain an inventory in Hong Kong.

It was the understanding

of B&L that any office that maintained inventory in Hong Kong had
to be incorporated in Hong Kong.
The Ophthalmic Division of B&L Inc. decided to incorporate
B&L Hong Kong in 1972 for the primary purposes of distributing
sunglasses and other B&L products in Hong Kong and related
markets in Southeast Asia and improving customer service and
expanding B&L's business in Southeast Asia.

In connection with

the decision to establish distribution operations in Hong Kong,
B&L considered Hong Kong's labor costs, its political stability,
its historic role as a trading center, any logistical difficulty
of managing the Asian distribution function from Rochester, and
the inadequacy of its marketing and sales in Southeast Asia, in
particular in Hong Kong, because of its reliance on independent
distributors.
From 1972 through 1981, B&L Hong Kong functioned, inter
alia, as a marketing, sales, warehousing, and distribution
facility that purchased sunglasses, contact lenses, contact lens

11

The Ophthalmic Division was one of two main divisions of B&L
Inc. at the time the decision to incorporate B&L Hong Kong was
made.

- 9 solutions, ophthalmic frames and lenses, scientific instruments,
and other B&L products from related suppliers and sold them
primarily to unrelated customers in Hong Kong, Taiwan, the
Philippines, Singapore, Malaysia, Thailand, and Indonesia.
During those years, B&L Hong Kong's largest selling products were
sunglasses that it purchased from B&L and that it did not assemble in Hong Kong, and its largest sales market for those
sunglasses was Hong Kong.

Throughout the period 1972 through

1981, B&L Hong Kong, and not B&L Inc., made the decisions affecting B&L Hong Kong's operations that related to its (1) leasing
facilities, (2) personnel, (3) selection of the B&L product lines
it offered, (4) B&L product inventory levels, (5) processing and
billing of customer orders, and (6) account management.

During

those years, B&L Hong Kong expanded its sales of B&L products
from approximately $300,000 to $10 million.
B&L's management was aware that the tax rates in Hong Kong
were lower than the tax rates in the United States during and
immediately prior to the years at issue, and B&L's management
made efforts during those years to reduce its overall tax burden.
B&L Sunglasses
B&L began producing sunglasses in 1930 in response to an
inquiry from the U.S. Army Air Corps, whose pilots needed protection from the glare of the sun while flying above the clouds.
B&L began marketing sunglasses to the general public in 1936.

- 10 Since 1937, B&L has marketed its sunglasses principally under the
name "Ray-Ban".
Ray-Ban sunglasses are premium quality sunglasses that are
priced two-to-ten times higher than regular sunglasses.

Ray-Ban

sunglasses contain optical-quality, glass lenses that are impact
resistant and designed to protect the wearer from harmful ultraviolet rays without distorting his or her natural vision.
B&L produced, inter alia, the following styles of sunglasses, all of which bore the logo Ray-Ban:

(1) Sunglasses with

metal temples and fronts and glass lenses that B&L and we refer
to as metals or metal sunglasses,12 (2) sunglasses with metal
temples and fronts covered in whole or in part with leather and
glass lenses that B&L and we refer to as leathers, (3) sunglasses
with plastic temples and fronts and glass lenses that B&L and we
refer to as plastics or plastic sunglasses,13 and (4) sunglasses
with nylon temples and fronts14 and glass lenses that B&L and we
refer to as Cats.

B&L also produced sunglasses with metal

temples and fronts and a one-piece plastic shield as a lens that
B&L and we refer to as Wings.
B&L used stock keeping units (SKUs) to keep track of the

12

Metals included styles of sunglasses known as large metals,
large metals II, Outdoormans, and Caravans.
13

14

Plastics included a style of sunglasses known as Wayfarers.

B&L purchased the nylon temples and nylon fronts from an
unrelated vendor.

- 11 finished sunglasses that it produced and sold.

Every different

type of finished sunglass product made by B&L was assigned a
different SKU and represented a separate inventory item.

Any

variation in the sunglasses caused them to be assigned a different SKU.

Thus, for example, if two pairs of large metals

contained different colored lenses, or two pairs of Wayfarers
were made with different colors of plastic, they were assigned
different SKUs even though they were identical in every other
respect.
Prior to and during the years at issue, B&L's primary
facilities for producing sunglasses were located in Rochester.
B&L performed both parts fabrication and assembly in Rochester.
B&L treated parts fabrication and assembly as separate operations
and, regardless of location, considered its assembly facilities
as customers of its parts fabrication facilities.
For all relevant periods until sometime in 1986, B&L produced the glass lenses for its Ray-Ban sunglasses in its glass
plant in Rochester (glass plant).

The glass plant used a large

glass tank capable of being subjected to extreme heat to turn
sand and oxides into a molten material that could be pressed into
shape for use as lenses in Ray-Ban sunglasses.

Because plastic

lenses had taken over the market for prescription eyeglasses by
1986, the glass plant was not commercially viable and was closed.
B&L licensed its glass lens-making technology to Schott Glass

- 12 Technology (Schott Glass), an unrelated third-party vendor that
specialized in making glass products.

B&L worked closely with

Schott Glass to ensure that it produced quality lenses for use in
Ray-Ban sunglasses.
B&L fabricated the parts for its metals in its Frame Center
in Rochester (Frame Center) and its plant in Pforzheim, Germany,
that was operated by B&L GmbH, a subsidiary of B&L Inc.15

B&L

put metal wire through a multiple-step process in order to
produce the parts known as metal temples or fronts that were used
in assembling certain of its sunglasses.

Machines were used to

draw, form, bend, or cut the metal wire and to press holes into
the parts to create threaded holes.

An electroplated coating was

applied to the metal temples and fronts.

As part of the process

of fabricating metal sunglass parts, metal temples and fronts
were subjected to 20 to 40 specific inspection steps, some of
which involved random samples.
In the process of fabricating plastic frames, sheets of
plastic were pressed by B&L to cut out plastic temples and
fronts.

Hinges were attached during the process.

In the case of

the plastic temples, heated wires were inserted into the temples
in order to enable them to hold adjustments to their shape.

As a

final step to B&L's fabrication of plastic frames, the plastic

15

B&L also conducted some aspects of its sunglass operations in
Oakland, Maryland.

- 13 temples or fronts were placed into a tumbling barrel, which
contained wooden chips and wax to round their edges and polish
them.
B&L worked hard to ensure the quality of its sunglasses
during both the fabrication of parts for sunglasses and the
assembly of those parts into finished sunglasses.

Regardless

where the parts were fabricated and assembled into finished
sunglasses, B&L maintained strict quality standards and specifications that the parts and finished sunglasses were required to
meet.

Specifications for all sunglasses were established by the

specifications group at the B&L Frame Center in Rochester.
Establishment by B&L of New Sunglass Assembly Facilities
During the 1970s, B&L experienced tremendous growth in its
sunglass sales.

Much of that growth was in international

markets, especially Western Europe and Southeast Asia.

By 1982,

approximately half of B&L's sunglass sales were outside the
United States.

To help meet that demand, B&L increased the

output of its sunglass production facilities in Rochester during
the 1970s and continued to do so during the years at issue.
Prior to 1982, B&L operated a sunglass assembly facility in
France that it decided to close.

Because of the tremendous

growth of its sunglass sales in Europe and elsewhere, it needed
(1) to replace that facility in order to supply its European
markets and (2) to expand its worldwide sunglass production.

- 14 Although B&L considered further expanding its sunglass assembly
facility in Rochester and opening sunglass assembly facilities in
other places, it determined that Ireland was the best site for
the establishment of a new sunglass assembly facility.
The primary reason for the selection of Ireland as a site
for a sunglass assembly facility was the availability of grants
from the Industrial Development Authority of Ireland (IDA) and
other incentives provided by the Government of Ireland.

The IDA,

established pursuant to the Industrial Development Act of 1969,
was responsible for promoting industrial development in Ireland.
Its principal objective was to encourage Irish and foreign
industrialists to establish operations in Ireland.

Although the

IDA helped companies organized in Ireland that did not export
products from Ireland, certain service-industry companies, and
small businesses, it favored those businesses setting up manufacturing operations that planned to export products from
Ireland.

The IDA offered a wide range of economic and financial

incentives to firms that established operations in Ireland,
including (1) capital grants in amounts up to 45 percent of the
total cost of plant and equipment and (2) training grants in
amounts up to 100 percent of the expenditures incurred to train
employees.
On or about June 23, 1982, B&L submitted to the IDA a draft
proposal (IDA draft proposal) for the establishment of a sunglass

- 15 facility in Waterford, Ireland, to be located in the Waterford
industrial estate in which B&L Ireland's contact lens facility
was located.

The IDA draft proposal was prepared in the format

set forth in the IDA's "Guide to the Submission of Industrial
Proposals".
On or about October 6, 1982, B&L Ireland and the IDA entered
into an agreement (IDA grant agreement) pursuant to which the IDA
agreed to provide B&L Ireland with (1) capital grants equal to 40
percent of B&L Ireland's (a) annual rent, (b) expenditures for
factory-building modifications, and (c) purchases or leases of
new machinery and equipment and (2) training grants equal to 100
percent of B&L Ireland's training costs.

In order to receive the

capital grants under the IDA agreement, B&L Ireland was required
to follow certain procedures, including filing an auditor's
certificate to verify its actual capital expenditures.

It

received capital and training grants from the IDA by submitting
the required documented claims for such grants.
Contemporaneous with the IDA grant agreement, B&L Ireland
and the IDA entered into a lease and option agreement (unit 107
lease and option agreement) pursuant to which B&L Ireland leased
and was granted an option to purchase from the IDA unit 107 in
the Waterford industrial estate that had an approximate size of
6,700 square feet.

At the same time, but in a separate agree-

ment, the IDA also agreed to grant a rent subsidy to B&L Ireland

- 16 with respect to the unit 107 lease and option agreement.
B&L Ireland entered into additional leases with the IDA.

On

or about April 27, 1983, it executed an agreement to lease unit
102 in the Waterford industrial estate to use as a temporary
storage facility for raw materials.

In 1984, B&L Ireland leased

from the IDA a warehouse facility that had an approximate size of
6,000 square feet.

In late 1987, it moved its sunglass assembly

operations to a new facility that had approximately 19,000 square
feet.16
B&L Ireland received additional financial incentives from
the Government of Ireland in the form of certain exemptions from
Ireland's corporation tax and its value added tax (VAT).

With

respect to Ireland's corporation tax, Ireland generally exempted
from that tax income earned through export sales of goods manufactured in Ireland.

Pursuant to that exemption, B&L Ireland was

relieved of its obligation to pay Ireland's corporation tax with
respect to substantially all, if not all, of its profits from its
sunglass assembly operations.

With respect to Ireland's VAT,

Ireland generally exempted from that tax firms engaged in a
manufacturing business that were importing the goods used in that
business.

Pursuant to that exemption, B&L Ireland was exempt

from VAT on items it purchased from B&L Inc. and B&L GmbH for use

16

It is unclear from the record whether B&L Ireland leased or
purchased the facility into which it moved its sunglass assembly
operations during 1987.

- 17 in its sunglass assembly operations in Ireland.
In addition to incentives provided by the IDA and the
Government of Ireland, B&L considered the following factors in
selecting Ireland as the site for a sunglass assembly facility:
(1) The ability to have goods shipped from Ireland duty-free
within the European Economic Community (EEC) because of that
country's membership in the EEC, (2) Ireland's proximity to North
Africa, the Middle East, and Europe, (3) Ireland's low labor
costs, and (4) economies gained by association with the existing
contact lens facility in Waterford, Ireland.
In addition to opening a sunglass assembly facility in
Ireland during 1982, B&L decided to open a sunglass assembly
facility in Hong Kong during that year.

During the early 1980s,

B&L Hong Kong experienced rapid growth in the sale of sunglasses
that it purchased from B&L.

Because it experienced long lead

times on finished sunglasses shipped from the United States, B&L
Hong Kong found it necessary to maintain large inventories to
avoid running out of certain SKUs of sunglasses.

The cost of

maintaining large inventories during the early 1980s was high
because interest rates were approximately 18 percent at that
time.

In an effort to reduce costs and improve customer service,

in early 1981, Mr. Y.H. Chan, the managing director of B&L Hong
Kong from 1975 and throughout the years at issue, proposed to
William Godfrey (Mr. Godfrey), the president of B&L Inc.'s

- 18 Consumer and Ophthalmic International Division,17 that B&L Hong
Kong assemble sunglasses in Hong Kong.

Mr. Godfrey approved the

decision on behalf of B&L Inc. to establish a sunglass assembly
facility in Hong Kong.
factors:

His decision was based on the following

(1) Because the parts for different SKUs of Ray-Bans

were interchangeable, B&L Hong Kong could reduce its finished
goods inventory yet process customer orders faster by assembling
the sunglasses in Hong Kong;18 and (2) because labor and overhead
costs were cheaper in Hong Kong than in the United States, the

17

The Consumer and Ophthalmic International Division succeeded
the Ophthalmic Division as the division of B&L Inc. responsible
for overseeing B&L Hong Kong.
18

For example, B&L produced different SKUs of sunglasses that
used the same type of frame, but lenses of different colors.
Lenses of the same design also were used interchangeably in
certain different styles of sunglass frames. Each style of frame
with each color of lens represented a different SKU. If B&L Hong
Kong had not decided to assemble sunglasses in Hong Kong, it
would have needed to maintain a finished goods inventory for
every SKU in order to process orders quickly. By maintaining a
sunglass assembly facility in Hong Kong, B&L Hong Kong was able
to process an order without needing to maintain a finished goods
inventory for every SKU. Rather, it simply needed to maintain an
adequate supply of the interchangeable parts. By way of illustration, if B&L Hong Kong had not conducted assembly operations
in Hong Kong and had estimated that it would sell 100 pairs of
large metals, but had been unable to estimate whether its sales
would be for large metals with green or with gray lenses, it
would have needed to stock 100 finished pairs of each of those
SKUs. However, if B&L Hong Kong were to conduct assembly
operations, it could fill an order for 100 large metals with gray
lenses, 100 large metals with green lenses, or some combination
thereof simply by maintaining 100 pairs of frames for large
metals, 100 pairs of gray lenses, and 100 pairs of green lenses.
Thus, the total number of frames in B&L Hong Kong's inventory
could be less than the number of frames in its inventory if it
maintained enough finished goods inventory to fill those orders.

- 19 overall cost to B&L to produce a pair of sunglasses was reduced.
From 1982 through 1987, B&L Hong Kong leased facilities in
the Watt's Industrial Building in Hong Kong for its sunglass
assembly operations.

During the period 1983 through 1985, B&L

Hong Kong leased 1,200 square feet for those operations.

During

1986 and 1987, it increased the amount of space it leased to
8,000 square feet, 4,000 square feet of which was used for
production and 4,000 square feet of which was used as a warehouse.

B&L Hong Kong leased additional space for offices for

managers and other personnel involved in its sunglass assembly
operations.
In addition to assembling sunglasses, B&L Hong Kong continued to act as a marketing and distribution company for other
B&L products, including sunglasses assembled outside of Hong
Kong.
Licenses of Intangibles to B&L Ireland and to B&L Hong Kong
Pursuant to license agreements, B&L Inc. granted to B&L
Ireland and B&L Hong Kong, respectively, nonexclusive licenses to
use certain technology relating to sunglass assembly.19

19

Pursu-

Except as stated below, the sunglass assembly operations
conducted by B&L Ireland and by B&L Hong Kong were substantially
the same. The sunglass assembly operations conducted by B&L Inc.
in Rochester with respect to metals, plastics, Wings, and
leathers were substantially similar to the sunglass assembly
operations conducted by B&L Ireland with respect to those styles
of sunglasses and by B&L Hong Kong with respect to those styles
except plastics that B&L Hong Kong did not produce. Even at its
(continued...)

- 20 ant to those respective license agreements, B&L Inc. provided to
B&L Ireland and B&L Hong Kong specifications for sunglass assembly, production know-how and training, ongoing technical assistance and support, standard operating procedures, and other
documents and information relating to the sunglass assembly
process.

B&L Ireland and B&L Hong Kong paid royalties to B&L

Inc. for the use of such technology.
B&L Ireland and B&L Hong Kong were required to assemble B&L
sunglasses in accordance with the specifications for such sunglasses established by B&L Inc.

Although B&L Ireland and B&L

Hong Kong were able to recommend changes in the specifications,
they were not free to ignore the specifications established by
B&L Inc.
Management Functions at B&L Ireland and B&L Hong Kong
B&L Ireland employed between 55 and 66 employees, including
the following supervisors (also known as managers) who were
responsible for the conduct of B&L Ireland's sunglass assembly
operations:

(1) A plant manager who was responsible for ensuring

that the plant was properly sized for the volume of production
the plant was required to generate and for ensuring the coordina-

19

(...continued)
facilities in Rochester, B&L Inc. treated sunglass assembly as a
separate function from the fabrication of sunglass parts. The
assembly operations at B&L Inc., B&L Ireland, and B&L Hong Kong
received some parts from the same parts warehouse located in
Rochester.

- 21 tion of the activities of the senior managers who reported to him
or her, (2) a production or manufacturing supervisor who was
responsible for the supervision and organization of plant personnel and who ensured that all resources (i.e., equipment and
manpower) were in place and that training was properly undertaken
and reported to the IDA, (3) a materials supervisor who was
responsible for preparing the production plan for the plant and
ensuring that all parts were properly ordered and arrived at the
plant in time for processing, and (4) a quality assurance and
engineering supervisor who was responsible for ensuring that the
parts supplied to the plant and the finished products leaving the
plant met the quality standards that apply to B&L sunglasses.
B&L Ireland also had other management staff who were responsible
for finance and accounting, human resources, and other functions.
The plant manager and the senior management personnel normally
met on a weekly basis as a management team to work on policy or
other issues.
The management of B&L Ireland was responsible for planning
the production of B&L sunglasses in Ireland.

That process, known

as the production planning process, involved several stages.
Approximately six months prior to the beginning of a fiscal year,
the senior management team met to prepare a production budget.
The production budget was based upon the customer sales and
demand forecasts supplied to B&L Ireland by B&L Inc. and upon

- 22 instructions from B&L Inc. as to which SKUs B&L Ireland was to be
responsible for assembling.

The production budget was designed

to identify the resources (i.e., the necessary personnel and
sunglass parts) required to meet the production plan.

The next

stage of the production planning process was to prepare the
production forecast.

That occurred approximately three months

prior to the planned production and allowed B&L Ireland to order
the necessary sunglass parts from B&L Inc. and B&L GmbH in time
to begin the required production.

The next phase in the produc-

tion planning process was to prepare a production schedule that
occurred one to two weeks in advance of actual production.

The

production schedule was prepared by the production supervisor and
the materials supervisor and was based on what parts and production personnel were available at that time to meet required
production as set by B&L Inc.

Manufacturing orders were issued

from the production schedule.

The manufacturing orders specified

which SKU of sunglasses was to be assembled.

Based on the

manufacturing order, parts were issued to the operator (viz., the
assembler) so that the assembly process could begin.
B&L Ireland was responsible for hiring its own production
personnel and for negotiating union contracts for its sunglass
assembly operations.

B&L Ireland also retained outside consult-

ing firms (1) to develop a job evaluation system for determining
the relative level of skill required to perform the various

- 23 functions performed by B&L Ireland (including its contact lens
operations) and (2) to assess the relative level of efficiency
achieved by the employees in its sunglass assembly operations and
to recommend work standards to improve that level of efficiency.
B&L Ireland maintained a management accounting system for
its sunglass assembly operations that was separate from the
accounting system for its contact lens operations.

The account-

ing system for B&L Ireland's sunglass assembly operations was
based upon standard cost accounting under which standard costs
were established for materials, labor, and overheads, and the
actual costs for those items were compared against those standard
costs to determine any variances.

B&L Ireland prepared monthly

reports based on its accounting system in order to aid it in
monitoring its sunglass assembly operations.

B&L Ireland's cost

accounting system was indicative of a manufacturing company and
not a distribution operation.
B&L Hong Kong's sunglass assembly operations utilized
between 22 and 31 employees, including the following supervisors
and managers who were responsible for its sunglass assembly
operations:

(1) A managing director who had overall respon-

sibility for B&L Hong Kong's operations (including operations
other than the assembly of sunglasses), (2) a production manager
who was responsible for the overall production of sunglasses,
including quality control, process improvement, manpower alloca-

- 24 tion, ordering of the parts for production, and production
scheduling, and (3) an assistant production supervisor and two
group leaders who were responsible for the day-to-day production
operations.

The managing director reported to an employee of B&L

Inc.
The monthly production plans for B&L Hong Kong were prepared
by the production manager based upon information supplied to him
by B&L Hong Kong's sales and marketing personnel, the amount of
goods on hand, and the customer back orders on hand.

B&L Inc.

did not decide which SKUs of sunglasses B&L Hong Kong was to
assemble or sell.

B&L Hong Kong's management was responsible for

those decisions.

From the monthly production plans that were

based on finished sunglasses, the production manager prepared a
weekly production schedule for each day in each week.

The

production manager also was responsible for ordering parts by
taking into account the sales forecast, customer orders, the
finished goods inventory on hand, the parts on hand, and the
parts on order from B&L Inc.20

Starting in 1984, the parts

orders were prepared by B&L Hong Kong using a computer system
that utilized software developed for B&L Hong Kong by an outside
vendor it had hired.

20

Prior to placing an actual order for parts, B&L Hong Kong
also prepared a quarterly report that it sent to B&L Inc. in
Rochester to alert it to B&L Hong Kong's expected needs for
parts.

- 25 Like B&L Ireland, B&L Hong Kong maintained a management
accounting system based upon standard cost accounting to compare
its actual performance data to its standard budgeted data and
prepared monthly reports based on that system in order to assist
it in monitoring its business.

The production manager was

responsible for establishing the standard costs based on historical data and time and motion studies.

B&L Hong Kong's cost

accounting system was indicative of a manufacturing company and
not a distribution operation.
Training of Personnel
When B&L Ireland commenced its sunglass assembly operations
in November 1982, the initial training for operators at B&L
Ireland was provided by an individual employed by B&L Inc. and
lasted approximately three weeks.

Around May 1983, an additional

instructor employed by B&L Inc. provided approximately four weeks
of training to B&L Ireland's sunglass assembly personnel.

B&L

Ireland's personnel also traveled to Rochester to train in the
assembly of new SKUs.
Shortly after commencing operations, B&L Ireland hired
quality assurance inspectors to inspect the finished sunglasses
it assembled.

The initial training for inspectors was provided

by an individual employed by B&L Inc. in the United States.
Approximately 80 percent of the sunglasses produced at the B&L
Ireland sunglass assembly facility during the initial stages of

- 26 production failed a quality inspection and were returned to the
original operator for reworking.
B&L Ireland undertook a number of steps to improve the
quality of the sunglasses it produced.

In May 1983, B&L Ireland

established its own training program to ensure that its employees
were competent to produce quality sunglasses.

At that time, B&L

Ireland employed one of its quality assurance auditors to serve
as a full-time instructor.

During 1985, B&L Ireland hired a

second full-time instructor to become an instructor in assembling
metal sunglasses.
In a further effort to improve the quality of the sunglasses
it assembled and in order to help B&L Ireland establish standard
operating procedures for its sunglass assembly operations, during
1984, B&L Ireland's sunglass assembly operations underwent a
quality audit performed by the quality manager of its contact
lens operation.

Shortly thereafter, the quality assurance

manager for the sunglass assembly operations was replaced.

In

its production budget for its second year of operations (viz.,
1984), the management of B&L Ireland also reduced the estimated
number of SKUs to be produced by it as part of its continuing
effort to improve the quality of the sunglasses it assembled.
B&L Ireland's training program for operators lasted 13
weeks.

When a new operator started, the instructor showed that

person the workstation and told that person the names of the

- 27 parts, tools, and equipment he or she was to use.

For the first

week of training, the new operator assembled parts that had been
rejected by the quality assurance personnel.

Beginning in the

second week of training, the new operator started to assemble
sunglasses from parts that had passed inspection as acceptable
for use in B&L sunglasses.

The new operator received one-on-one

instruction in assembly techniques from an instructor.

The time

that the instructor spent with the new operator decreased as the
training period progressed.
Beginning in the second week of the training program, the
new operator was given targets for the quantity and quality of
sunglasses to be assembled.

For fully-trained operators, B&L

Ireland established a target for assembly of 200 sunglasses per
day.

The target during the second week of instruction was

approximately 25 percent of that amount or 50 sunglasses per day.
During the first few weeks of training, the percentage of salable
sunglasses assembled by the typical new operator was very low.
The typical new operator was able to produce only approximately
70 percent of B&L Ireland's established target of 200 sunglasses
per day at the end of the training period.

Typically, an oper-

ator required approximately six months of assembly experience
prior to reaching the target set by B&L Ireland.
Some operators were not able to reach a sufficient level of
proficiency to continue to function as operators and were trans-

- 28 ferred to other functions such as packaging and washing.

Not all

operators were proficient at assembling all types of sunglasses.
Whenever an operator began assembling a new style of sunglasses,
the operator was given additional training until that person was
comfortable and was able to produce sunglasses of sufficient
quality.

If an operator switched from assembling plastics to

assembling metals, the operator was given an additional 13 weeks
of training.
Training for inspectors at B&L Ireland lasted 13 weeks,
regardless whether the individual being trained had been an
operator prior to that time.

An additional 13 weeks of training

was required if the inspector switched from the inspection of
metals to the inspection of plastics.
Training for other functions, such as packaging and washing,
lasted four weeks.

When B&L Ireland began applying leather to

metal frames in 1986, the training for the leather application
process lasted eight weeks.

B&L Ireland conducted retraining

programs for operators who were having difficulty meeting quantity and quality standards.

Those programs typically lasted four

weeks.
Most quality problems at B&L Ireland with respect to the
basic SKUs tended to disappear over time as B&L Ireland's management and operators became more experienced in assembling those
types of sunglasses.

However, as new styles of sunglasses were

- 29 added to B&L Ireland's products, new quality problems arose.
Like B&L Ireland, before becoming fully operational, B&L
Hong Kong underwent an initial period of training those involved
in the sunglass assembly operations.

Employees of B&L Hong Kong

went to Rochester to observe B&L Inc.'s assembly operations, and
employees of B&L Inc. traveled to Hong Kong to help train employees of B&L Hong Kong.

B&L Hong Kong also established a pilot

program in which its employees assembled sample batches of
sunglasses to send to B&L Inc. in Rochester for approval.

Just

as B&L Ireland experienced quality problems in the early stages
of its operation, B&L Hong Kong was unable to meet its quality
standards during 1983.
Unlike B&L Ireland, B&L Hong Kong did not hire any full-time
instructors.

Rather, training of new operators, inspectors, or

other production personnel was handled by B&L Hong Kong's assistant production supervisor and group leaders.

A new operator

received one-on-one supervision for the first two or three weeks
of training to teach that person the basic techniques of assembling sunglasses.

An inspector kept track of the defective

sunglasses assembled by the new operator in order to determine
the areas in which the new operator needed to improve.
The typical new operator achieved B&L Hong Kong's basic
daily productivity target of 150 units per day within four to six
weeks after the commencement of the training program.

During the

- 30 first few weeks of training, the percentage of salable sunglasses
assembled by the typical new operator was very low.

A typical

operator became skillful in the assembly of basic SKUs of sunglasses within nine to twelve months, but was not able to reach
B&L Hong Kong's average output of 380 pairs of sunglasses per
operator per day until sometime during that person's second year
of employment.

Some new operators failed to reach the minimum

target level and were transferred to other areas.
Most inspectors at B&L Hong Kong started as operators and
received an additional six to eight weeks of training to become
qualified inspectors.
Purchase of Parts by B&L Ireland and by B&L Hong Kong
B&L Ireland and B&L Hong Kong purchased from B&L Inc. metal
fronts and temples, glass lenses, screws, packaging materials,
and other parts and materials that they used in their respective
sunglass assembly operations.

B&L Ireland also purchased metal

fronts and temples from B&L GmbH and plastic fronts and temples
from B&L Inc.

During 1987, B&L Ireland purchased nylon frames

from Bolle, a French company unrelated to B&L, that B&L Ireland
used to assemble Cats sunglasses.

B&L Ireland assembled and sold

no more than 35 pairs of Cats during 1987.
The amounts paid by B&L Ireland and by B&L Hong Kong to B&L
Inc. and by B&L Ireland to B&L GmbH for fronts, temples, lenses,
and other materials used in their respective sunglass assembly

- 31 operations were equal to B&L Inc.'s and B&L GmbH's respective
standard costs of such parts or materials plus (1) 15 percent in
1983, (2) 20 percent in the first six months of 1984, and (3) 30
percent for the remainder of 1984 through 1987.

Both B&L Ireland

and B&L Hong Kong communicated with their suppliers (i.e., B&L
Inc. and B&L GmbH with respect to B&L Ireland and B&L Inc. with
respect to B&L Hong Kong) to identify and improve quality problems with respect to the parts they purchased from them.
B&L Ireland and B&L Hong Kong were responsible for managing
and controlling the parts and materials used in their respective
sunglass assembly operations.

Each company maintained part

numbers for each of the parts and materials that it purchased and
used those part numbers for inventory control and management
purposes.

B&L Ireland and B&L Hong Kong typically received parts

in boxes containing 50 or more units of a single item (i.e., a
single part number).

Each box of 50 or more units was referred

to as a lot.
At B&L Ireland, the quality assurance department inspected
purchased parts (incoming inspection) to screen out nonconforming
or defective parts, identify problems that might arise during the
production process, and identify opportunities to work with its
suppliers to improve quality.

To perform the incoming inspec-

tion, a trained inspector selected a random sample of parts from
each lot, examined the parts visually and with various gauges and

- 32 tools to identify cosmetic or aesthetic defects and dimensional
defects, and marked each defective part.

The inspector compared

the total number of rejected parts to a standard to determine
whether the lot passed or failed the incoming inspection.

If too

many of the purchased parts of a particular lot were determined
to be defective, the inspector placed the failed lot in quarantine.21

If the purchased parts passed inspection, B&L Ireland's

materials management department stored the parts in inventory
until they were needed for assembly.
At B&L Hong Kong, the incoming inspection was performed by
each operator who was trained and responsible for checking the
parts prior to assembling them to ensure that they were of
acceptable quality for assembly.

If the operator found any

defects, he or she was to ask the storekeeper to exchange the
defective parts for nondefective parts.

The storekeeper, who was

also trained to perform quality inspections, verified whether
those parts submitted by the operator were in fact defective.

If

they were defective, the storekeeper replaced them; if they were
not defective, the storekeeper returned them to the operator for
assembly.

B&L Hong Kong employed an individual to repair repair-

able defective parts so that those parts could be used to as-

21

Parts placed in quarantine by B&L Ireland were not used for
assembling sunglasses unless absolutely necessary. If it became
necessary to use the quarantined parts, those parts were inspected to sort out the unusable parts. Quarantined parts were
sometimes reworked to make them acceptable before they were used.

- 33 semble sunglasses.
Even if the parts purchased by B&L Ireland and by B&L Hong
Kong had passed the incoming inspections conducted by each of
those companies, an operator still could have experienced some
difficulty in assembling those parts due to a problem known as
tolerance stacking.

Because the incoming inspections at both B&L

Ireland and B&L Hong Kong tested to established tolerances,
purchased parts were permitted to deviate from the nominal
specification (viz., the ideal size) for those parts within a
certain range and nonetheless pass inspection.

For example, if

an operator had attempted to insert a lens that was larger than
the nominal specification into a frame that was smaller than the
nominal specification, the operator may not have been able to
assemble those parts correctly.
Metals
At both B&L Ireland and B&L Hong Kong, the operator received
the parts to be assembled along with a manufacturing order
detailing the SKU to be assembled.

The operator began assembling

the metals by picking up a front and using a screwdriver to open
the left and right lens screws in the endpieces on the fronts by
turning them three revolutions to permit the operator to attempt
to insert the lenses properly without damaging the lenses or the

- 34 front.22

The operator manipulated the right and left lenses into

the respective eyewires of the front in a manner intended to
avoid canted eyes (i.e., improper rotation and seating of the
lenses in the fronts), partially assembled sunglasses (on which
the lens could pop out after the lens screw had been tightened),
and chipped or scratched lenses.

If the lens had been larger

than the nominal specification for lenses, or the frame had been
smaller than the nominal specification for frames, the operator
might have had to turn the lens screw more.

If the operator had

opened the lens screw too far, the screw might have popped out of
the hole and the operator would have had to begin the process
again.

On the other hand, if the operator had not opened the

lens screw far enough, the operator, by applying too much pressure trying to force the lens into place, might have chipped the
lens, which would have caused the lens to be rejected as unacceptable for use in B&L sunglasses.
After inserting the lenses, the operator inserted a temple
into the endpiece of the front, aligning the holes of the temple
with the holes of the endpiece.23

The operator maintained that

alignment with one hand and picked up a tiny screw that was 2.5
to 3 millimeters in length and .5 to 1 millimeter in diameter and

22

B&L and we refer to the process of inserting lenses into the
fronts as lensing.
23

B&L and we refer to the process of attaching the temple to
the front as templing.

- 35 inserted it into the temple.

Using a screwdriver, the operator

partially tightened the temple screw, fully tightened the lens
screw, and fully tightened the temple screw.

The operator

repeated the templing process with respect to the other temple.
If the operator had applied too much pressure to the screws when
tightening them, the following damage, any of which would have
made the affected part unacceptable, might have occurred:

(1) A

cracked lens, (2) a chipped lens, (3) stripped or chipped screw
head, (4) stripped screw threads, (5) stripped threads inside the
temple or endpiece holes, and (6) broken solder on the endpiece.
Following completion of the lensing and templing procedures,
the operator inspected the sunglasses for any damage to the parts
that occurred during the assembly process and replaced any
damaged parts identified.
The operator inspected both the left and right lens for lens
gaps (i.e, a gap between the lens and the frame).

If the oper-

ator had identified a lens gap, the operator would have adjusted
the curvature of the frame by manually bending the frame to meet
the curvature of the lens.

B&L Ireland and B&L Hong Kong fre-

quently encountered lens gap problems with respect to a style of
metals called Caravans that had square rather than round eyepieces.

This was because the curvature of the top of the Caravan

frame generally failed to meet the curvature of the lens.

At B&L

Ireland, operators were responsible for adjusting the curvature

- 36 of the Caravans prior to assembly.

At B&L Hong Kong, an in-

dividual known as a repairer was assigned to adjust the curvature
of the Caravan frames before they were given to the operators for
assembly.
The operator used an eyewire to identify any endpiece gap
(i.e., a gap between the top and bottom portions of the
endpiece).

If the operator had identified an unacceptable

endpiece gap, the operator would have used gapping pliers to
apply pressure to the endpiece so that he or she could have
further tightened the lens screw.

If the operator had applied

too much pressure to the pliers, he or she could have chipped the
lens or broken the solder on the endpiece.
The operator used a fitback board to identify and examine
the crossover angle (i.e., the angle of the temples when folded
in relation to a horizontal line joining the hinge centers), the
fitback angle (i.e., the angle formed by the temples in an open
position in relationship to the front), and the down angle (i.e.,
the angle formed by the front and temple in the open position) in
order to determine if those angles were within the specifications
established for the SKU being examined.

The operator also used

the fitback board to determine whether there were any rocking
temples (i.e., whether both temples had contact with the surface

- 37 when lying topside down on a flat surface).24

If the operator

had determined that an adjustment to the sunglasses was needed,
the operator would have used truing pliers to manipulate the
endpiece to the required angle.

If the operator had applied too

much pressure or otherwise misused the pliers when bending the
endpiece, the operator could have broken or marked the endpiece
or the temple, or chipped the lens.

If an adjustment had been

made, all angles would have been rechecked until no further
adjustment would have been necessary.
After the operator completed the truing process, the sunglasses were sent to trained inspectors at B&L Ireland and B&L
Hong Kong who performed an inspection of each pair of assembled
sunglasses to ensure that it conformed to the specifications for
the SKU being inspected (100-percent inspection).

Specifically,

the inspectors (1) inspected the temples and fronts for cosmetic
defects; (2) examined the crossover, fitback, and down angles and
made any necessary adjustments to the sunglasses; (3) determined
whether there were any rocking temples and made any necessary adjustments to eliminate them; (4) adjusted the nosepads; (5) examined the lenses for cosmetic defects (including any defects in
the trademark and logo markings) by (a) identifying any chips,
scratches, or digs, (b) measuring any such defects using a

24

B&L and we refer to the processes of examining and adjusting
the various angles and determining the presence of and eliminating rocking temples as truing.

- 38 scratch and dig plate, and (c) comparing any such defects to the
standard allowable size and number of such defects that varied
depending on the location of the defects and the SKU being
assembled; (6) examined the sunglasses for the presence of any
lens gaps and canted eye or other fit defects and made any
necessary adjustments to eliminate them; (7) inspected the
endpieces for endpiece gaps and screw quality; (8) identified any
rejected sunglasses and made the necessary repairs and/or replacements to those sunglasses; and (9) cleaned the sunglasses
with their gloves.
Following the 100-percent inspection, washers placed the
inspected metal sunglasses at B&L Ireland and at B&L Hong Kong in
a rack, washed the sunglasses in chemicals, rinsed the sunglasses
with Freon, placed the sunglasses in a drying chemical, and
placed the dried sunglasses into another rack.
After inspection and cleaning functions, packers packed each
pair of inspected sunglasses at B&L Ireland and at B&L Hong Kong.
The packer determined if any special packing material was necessary by reference to a special packing manual, placed a hang tag
on the left temple if specified, closed the left and right
temples, placed the sunglasses in a case, and placed the specified quantity in a finished goods box.

After completing the

packing process, the packer verified the quantity in the box and
completed a quality sheet.

- 39 At B&L Ireland, the auditors, who were trained inspectors,
performed an audit of the finished sunglasses that had been
packaged to ensure that the products conformed to B&L's standards.

The auditor selected a random sample of the sunglasses

from a particular lot and performed inspection functions with
respect to that sample similar to the 100-percent inspection
performed by inspectors.

If the auditor had identified too many

defects in the samples inspected, the lot would have failed the
audit.

In that event, all the sunglasses in the lot would have

been returned to the inspector for another 100-percent inspection, and the inspector would have corrected any defects identified and would have sent the lot back to the auditor for
reauditing.
B&L Hong Kong did not have any personnel devoted solely to
carrying out the audit function with respect to finished sunglasses.

Its cleaners, who cleaned each sunglass unit with a

hand cloth following the washing process, and its packers were
trained in inspection procedures needed to perform the audit
function.

The cleaners and packers performed inspection func-

tions similar to the inspections conducted by B&L Ireland's
auditors.

However, rather than inspecting only a random sample

of each lot, each pair of sunglasses at B&L Hong Kong received a
second inspection conducted by the cleaners and packers.
Plastics

- 40 In addition to assembling metals, B&L Ireland's personnel
assembled plastics.

B&L Hong Kong did not perform any operations

that resulted in plastic sunglasses and did not even sell many
B&L plastic sunglasses assembled outside B&L Hong Kong.

This was

principally because the bridge on the plastics was too wide for
the average Asian face, which tended to be smaller than the
average Caucasian face, and, unlike metals, plastics did not have
nosepads that could be adjusted to fit the Asian face.
In assembling plastics, B&L Ireland's personnel used a
heating tunnel equipped with temperature and speed controls in
order to render the plastic fronts sufficiently malleable so as
to permit the insertion of the lenses and the formation of the
headcurve of the fronts.

The heating tunnel, which contained a

conveyor belt running through the machine, heated the front with
electrical elements located on the top of the tunnel.

Although

the specifications for a particular SKU established initial
settings for the temperature and speed, the operator was responsible for adjusting those controls as necessary to facilitate the
lensing process.

If a front had not been hot enough when it

exited the tunnel, the operator could not have inserted both
lenses without damaging either the fronts or the lenses.

On the

other hand, if the front had been too hot when it exited the
heating tunnel, it could have suffered heat damage such as sunken

- 41 plaques,25 bubbles, blisters, and cracks.
After the operator removed the heated front from the heating
tunnel, he or she removed the plastic protective caps from the
hinges with a decapper or pliers, placed the front on the metal
stretcher plate located on a pneumatic stretcher machine, and
activated the machine that compressed a top plate down on to the
stretcher plate, thereby stretching the eye cavities on the front
and partially forming the headcurve of the front.

The operator

removed the front from the stretcher plate, manipulated the
lenses into the eye cavities, manipulated the front to form the
proper headcurve for the SKU being assembled, measured the
headcurve using a headcurve chart, examined the fronts for
distortions, and checked for and corrected any lens gaps or other
defects.

The operator was required to complete the lensing

process before the front cooled down.
Prior to attaching the plastic temples to the fronts, the
operator was required to use a mitring machine to cut plastic
from the front end of the temples so as to create an angle that
conformed to the angle of the front.26

The operator adjusted the

cutting blade of the mitring machine, inserted and aligned a

25

The plaque is the metal piece on the plastic front. It
appears sunken when the plastic around the metal becomes so hot
that it swells and covers the plaque.
26

B&L and we refer to the process of cutting the temples with a
mitring machine as mitring.

- 42 temple so that the machine would cut the temple, and secured and
cut the temple.

If the operator had cut off too much plastic,

the temple would have been scrapped.

If the operator had cut off

too little plastic, the process would have been repeated.
After mitring the temple, the operator attached the temple
to the front.

He or she performed that function by inserting a

temple into the endpiece of the front, aligning the temple holes
with the endpiece holes, and, while maintaining that alignment
with one hand, picking up and inserting a tiny screw into the
temple hole with the other hand, and fully tightening the screw.
The process was repeated with respect to the other temple.
During certain periods from 1985 through 1987, operators at
B&L Ireland used a semiautomatic screwdriver to perform the
templing process with respect to plastic sunglasses.

The

operator aligned the temple and front and placed those parts on
the stand of the semiautomatic screwdriver.

The operator then

pressed a footpedal attached to that screwdriver that resulted in
securing a screw, inserting it into the temple holes, and fully
tightening it.

The process was repeated with respect to the

other temple.
After completing the templing process with respect to three
units in a lot, the operator performed a truing process on the
plastic sunglasses similar to the one conducted with respect to
metal sunglasses.

If the mitring on those three units had been

- 43 done properly, the operator would have completed the templing
process with respect to the remainder of the lot.

If the mitring

had not been done properly, the temples would have been remitred
if possible, or if not, they would have been scrapped and
replaced.
When necessary, operators at B&L Ireland removed cosmetic
blemishes from plastic sunglasses using a polishing machine that
had a spinning wheel with surfaces for polishing and buffing.
The operator held the blemish, which was marked with a yellow
grease pencil, to the polishing surface until it could not be
seen (or it was determined that the blemish could not be removed).

The operator used the buffing surface to remove the

polish from the lenses.
After the operator completed the lensing, mitring, templing,
truing, inspection, and any repair functions, the lot was sent to
the inspectors for a 100-percent inspection.

They performed an

inspection with respect to plastics that was similar to the
inspection performed with respect to metals.

If the sunglasses

passed the inspection, they were packed and audited in a manner
similar to the respective packing and auditing functions performed with respect to metals.
Leathers
During 1984 through 1987, personnel at B&L Ireland and at
B&L Hong Kong performed lensing, templing, truing, inspections,

- 44 packing, and audit processes with respect to leathers that were
substantially similar to those processes with respect to metals.
Beginning in 1986 and during 1987, B&L Ireland and B&L Hong
Kong applied leather to metal fronts (including headbars) and
temples prior to completing the lensing, templing, and truing
functions.

Those companies used a training manual prepared by

Tannereye Ltd., an unrelated company, to train their employees to
perform those functions.
In the leather application process during 1986 and 1987, the
operator mixed the ingredients for the primer, applied the primer
to the fronts27 using a syringe, and placed the primed fronts and
temples in a drying area for a minimum of eight hours (or, in the
case of black chrome fronts, placed them in an oven for two
hours, reprimed the fronts, and allowed them to dry for 24
hours).

The operator used acetone to remove primer from the

endpieces or bridge, since those areas had to be free of any
adhesive that would detract from their appearance.
Prior to applying leather to the primed fronts, the operator
inspected the leather, which had an inactive glue on the inside
surface, to ensure that it was free from flaws.

The operator

measured the leather (including marking where the nosepad arm was
located) and cut off any excess leather so that the leather piece
would fit the front.

27

The operator applied acetone to the side of

Primer was also applied to metal temples.

- 45 the leather with the glue on it to activate the glue and applied
the leather to the front.

The operator (1) used a soldering iron

to burn off any excess thread; (2) used modeling tools to press
the leather down to avoid gaps where the metal was showing; and
(3) placed the front in a pressurized trap that pressed the
leather tightly against the front to avoid problems with loose
leather that was not secured to the front.

After the operator

examined the fronts for defects in the leather application and
corrected any defects, the operator applied nosepads to the
leather fronts.
In order to apply leather to the headbar of the metal
fronts, the operator applied pressure to the headbar to deform
the front to allow room to apply the leather to the headbar.

The

operator applied the leather to the headbar in a manner similar
to that performed with respect to the application of leather to
the fronts.

When the leather was applied to the headbar, the

operator pushed the headbar back into place to re-form the front.
The operator applied leather to temples in a manner similar
to that performed with respect to fronts.

After applying the

leather to the temples, the operator used a vice to bend the
temples in order to form the required curve in the temples for
the SKU being assembled.
Wings
From 1984 through 1987, personnel at B&L Ireland and at B&L

- 46 Hong Kong performed templing, truing, inspection, packaging, and
audit processes with respect to Wings that were similar to those
processes performed with respect to metals.

However, Wings

required a different lensing technique because, unlike metals
that had two separate glass lenses, Wings had a lens consisting
of a one-piece plastic shield.

In the case of Wings, after

opening the screws and working the eyewire around the lens, the
operator inserted Wings pliers, one side of which was plastic and
the other side of which was rubber, between the nosepad and the
front and exerted pressure until the lens snapped into place.
Due to the design of the Wings lens, B&L Ireland and B&L Hong
Kong experienced more lens gap problems in the nasal area of
Wings than they experienced with most other styles of sunglasses.
In an attempt to minimize the lens gap, B&L Ireland developed and
used an adjusting tool known as the Wings Gap Eliminator.
After completing the truing process with respect to Wings
sunglasses, operators at B&L Ireland and B&L Hong Kong washed
those sunglasses in a hot water bath and a cold water rinse to
remove a protective coating from the lenses that was intended to
prevent scratching.
Sales of Sunglasses Assembled by B&L Ireland and by B&L Hong Kong
B&L Ireland and B&L Hong Kong assembled the following styles
and quantities of sunglasses:

- 47 B&L Ireland
Description
Metals
Plastics
Wings
Leathers
Others28
Total

1983

1984

721,000

406,828
529
54,657
171,469
165
633,648

721,000

1985

1986

1987

450,325
391,250
520
169,434
50,125
15,093
65,694
43,607
44,287
566,664
663,671

536,872
257,378
24,661
77,207
192,912
1,089,030

B&L Hong Kong
Description
Metals
Leathers
Wings
Others
Total

198329

452,262

1984

1985

1986

1987

383,860
38,391
18,528

426,546
42,545
26,379

440,779

495,470

428,012
35,902
16,085
8,008
488,007

456,312
39,176
4,078
3,701
503,267

B&L Ireland transferred the sunglasses it assembled to a
distribution warehouse located in Culembourg, Holland.
Ireland did not maintain a sales or marketing staff.

B&L
The market-

ing for B&L Ireland was handled by Bausch & Lomb United Kingdom
(B&L United Kingdom) in London.

The sunglasses assembled by B&L

Ireland were sold primarily for distribution in Europe and the

28

The category "Others" primarily included styles called Classic Colours and Precious Metals. Those styles were metals that
were coated with sprayed-on paint in the case of Classic Colours
or with a coating of rhodium and ruthenium in the case of Precious Metals. B&L Ireland experienced some difficulty in assembling Classic Colours and Precious Metals because the coatings on
those styles, which were applied by a third party, chipped off
very easily.
29

The record does not disclose the breakdown of the styles of
sunglasses assembled by B&L Hong Kong during 1983.

- 48 Middle East.

Most of its European customers were B&L subsidiar-

ies that operated warehouses in most of the European countries.
In the Middle East, most of B&L Ireland's customers were independent distributors that sold other products in addition to RayBans.

B&L Ireland did not sell any sunglasses in Ireland.

Not all of the B&L sunglasses sold in Europe and the Middle
East were assembled at the B&L Ireland sunglass assembly facility.

B&L Ireland tended to manufacture SKUs of the biggest

runners (i.e., the best selling styles of sunglasses) so that it
was not required to train employees to assemble those products
that were in less demand.
B&L Hong Kong sold the sunglasses it assembled for distribution in Southeast Asia.

It sold sunglasses directly to retail

optical shops in Hong Kong and sold to both related and independent distributors for distribution in the remainder of Southeast
Asia.

In addition to selling the sunglasses it assembled, B&L

Hong Kong sold B&L sunglasses not assembled by it as well as
other B&L products.
In general, B&L Ireland and B&L Hong Kong sold sunglasses at
prices equal to the international distributor list price (1) less
25 percent for related distributors and (2) less 10 to 15 percent
for unrelated distributors.
Neither B&L Ireland nor B&L Hong Kong assembled sunglasses

- 49 for distribution in the United States.

Nor did either company

sell sunglass parts to retailers except as replacements for
repair work.

Neither B&L Inc., B&L Ireland, B&L Hong Kong, nor

anyone else in the sunglass industry sold sunglass parts to the
ultimate consumer.
Tax Return Treatment
For each year at issue, petitioners reported none of the
income of B&L Ireland and of B&L Hong Kong from the sale of
sunglasses they assembled as income under subpart F of the Code
(subpart F).
For each of their taxable years ended December 30, 1984,
December 29, 1985, and December 28, 1986, petitioners reported
certain of B&L Hong Kong's income from sources other than the
sale of sunglasses assembled by it as subpart F income.30

Petit-

ioners did not report any of B&L Hong Kong's income as subpart F
income for its taxable year ended December 25, 1983.

A memoran-

dum prepared by B&L in connection with the tax audit of petitioners' taxable years ended December 25, 1983, and December 30,
1984, indicated that petitioners did not report any of B&L Hong
Kong's income as subpart F income for their taxable year ended
December 25, 1983, because that company "generated an overall
loss from subpart F operations" for that year.

30

It is not clear from the record what all of the sources of
B&L Hong Kong's reported subpart F income were for those years.

- 50 Polaroid
From 1960 through the early 1980s, Sidney P. Davis (Mr.
Davis) was an employee of Polaroid U.K., which marketed and
distributed sunglasses in the United Kingdom.

At the time he

joined Polaroid U.K., it sold sunglasses that were assembled for
it by Polarizer U.K., an unrelated company, from lenses that
Polaroid U.K. imported from the United States and from frames
purchased by Polaroid U.K.

After joining Polaroid U.K., Mr.

Davis, acting as a representative of that company, became the
production manager of the assembly operations conducted by
Polarizer U.K.

His work included improving the quality control

of the vendors supplying frames and training the Polarizer U.K.
staff in quality control procedures.

In Mr. Davis' view, the

Polarizer U.K. factory in which he worked was a manufacturing
unit engaged in production, and he was a manufacturing manager.
The assembly operations conducted by Polaroid U.K. and
Polarizer U.K. throughout the period during which Mr. Davis was
production manager were very similar to the assembly operations
conducted by B&L Ireland and by B&L Hong Kong.
chased, sorted, and inspected.

Parts were pur-

The parts were assembled into

finished sunglasses with each operator responsible for quality
control.

The finished sunglasses underwent a final inspection

before they were shipped.

- 51 OPINION
Evidentiary Matters
We deal first with the admissibility of certain facts and
exhibits to which the parties stipulated, but as to which the
parties preserved evidentiary objections in the stipulations of
facts.

At trial, we admitted those facts and exhibits into

evidence conditionally, subject to our ruling on their admissibility.
The bases for most of the objections in the stipulations of
facts are that certain stipulated facts and exhibits are inadmissible under rule 402 of the Federal Rules of Evidence because
they are not relevant as defined in rule 401 of those rules and
that, if such facts and exhibits are relevant, they are in any
event inadmissible under rule 403 of those rules.

We have

examined each of the stipulated facts and exhibits in question
and find each of them to be relevant.

Fed. R. Evid. 401.

In

addition, we find that the probative value of each of those facts
and exhibits outweighs any potential for unfair prejudice,
confusion, or other basis for inadmissibility stated in rule 403
of the Federal Rules of Evidence.

Accordingly, we overrule all

of the parties' evidentiary objections based on rules 401, 402,
and 403 of the Federal Rules of Evidence.
Each party also objected in the stipulations of facts to

- 52 certain stipulated exhibits on grounds of hearsay.

"'Hearsay' is

a statement, other than one made by the declarant while testifying at trial or hearing, offered in evidence to prove the truth
of the matter asserted."

Fed. R. Evid. 801(c).

Petitioners

objected to the following exhibits on those grounds:

(1) "The

Story of Bausch & Lomb", (2) "articles from a 'manufacturing
journal' prepared by Petitioners", (3) two "newspaper articles"
from "Democrat and Chronicle, July 20, 1987" and "USA Today, May
6, 1987", (4) "Bausch & Lomb Magazine, Vol. 4, No. 3, dated
September 1987", (5) "advertisements that appeared in Boating
Monthly, a Hong Kong Yachting Association publication, dated
November 1979", and (6) "a document prepared by petitioners".

We

find that, with the exception of the two newspaper articles,
petitioners and/or their agents prepared the exhibits in question
and that they are admissions by a party opponent within the
meaning of rule 801(d)(2) of the Federal Rules of Evidence that
are not hearsay.

We find that the two newspaper articles in

question are hearsay as defined in rule 801 of those rules, and
respondent has not argued that any exception to the hearsay rule
applies to those articles.
Respondent objected to one paragraph of a "memorandum from
D.L. McGinnis to D. Earhart, dated November 14, 1979" (McGinnis
memorandum) on the ground that it is hearsay included within

- 53 hearsay that is not otherwise admissible pursuant to rule 805 of
the Federal Rules of Evidence.

The paragraph at issue in that

memorandum, viz., the third narrative paragraph that begins
"Regarding salaries", relates D.L. McGinnis' notes from a conversation that he had with another individual concerning the availability of training grants from the IDA for B&L Ireland's contact
lens operations.

We find that that paragraph constitutes hearsay

within hearsay not otherwise admissible pursuant to rule 805 of
the Federal Rules of Evidence.
In conclusion, the two newspaper articles and the third
paragraph of the McGinnis memorandum are inadmissible hearsay.
We unconditionally admit into evidence the remaining stipulated
facts and exhibits to which the parties objected and make them
part of the record in these cases.
Foreign Base Company Sales Income--Section 954(d)(1)
Under subpart F (sections 951 through 964), a U.S.
shareholder of a CFC must include in gross income a pro rata
share of certain classes of income of that CFC including, inter
alia, foreign base company sales income.31

31

Section 954(d) pro

Sec. 951(a)(1) provides that a U.S. shareholder of a CFC must
include in gross income, inter alia, a pro rata share of the subpart F income of that CFC for the year ended during such shareholder's tax year. Sec. 952(a) defines the term "subpart F income" to include "foreign base company income". Sec. 952(a)(2).
Sec. 954(a) defines "foreign base company income" to include
(continued...)

- 54 vides in pertinent part:
(d) Foreign Base Company Sales Income.-(1) In General.--For purposes of subsection
(a)(2), the term "foreign base company sales income"
means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with
the purchase of personal property from a related person
and its sale to any person * * * where-(A) the property which is purchased * * * is
manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized, and
(B) the property is sold for use, consumption, or disposition outside such foreign country
* * *.
The legislative history of subpart F provides some guidance
on the meaning of foreign base company sales income.

In its

explanation of subpart F, the Senate Finance Committee stated:32
The "foreign base company sales income" referred
to here means income from the purchase and sale of
property, without any appreciable value being added to
the product by the selling corporation. This does not,
for example, include cases where any significant amount
of manufacturing, major assembling, or construction
activity is carried on with respect to the product by
the selling corporation. On the other hand, activity
such as minor assembling, packaging, repackaging or
labeling will not be sufficient to exclude the profits

31

(...continued)
"foreign base company sales income" as defined in sec. 954(d).
Sec. 954(a)(2).
32

The House Ways and Means Committee used similar language in
its report on subpart F. H. Rept. 1447, 87th Cong., 2d Sess.
(1962), 1962-3 C.B. 402, 466.

- 55 from this definition.
The sales income with which your committee is
primarily concerned is income of a selling subsidiary
(whether acting as principal or agent) which has been
separated from manufacturing activities of a related
corporation merely to obtain a lower rate of tax for
the sales income. * * * [S. Rept. 1881, 87th Cong., 2d
Sess. (1962), 1962-3 C.B. 703, 790.]
In their technical explanations of the bill enacting subpart F,
both the Senate Finance Committee and the House Ways and Means
Committee further explained that the definition of "foreign base
company sales income":
does not apply to income of a controlled foreign corporation from the sale of a product which it manufactures. In a case in which a controlled foreign corporation purchases parts or materials which it then
transforms or incorporates into a final product, income
from the sale of the final product would not be foreign
base company sales income if the corporation substantially transforms the parts or materials, so that, in
effect, the final product is not the property purchased. Manufacturing and construction activities (and
production, processing, or assembling activities which
are substantial in nature) would generally involve
substantial transformation of purchased parts or materials. [S. Rept. 1881, supra, 1962-3 C.B. at 949;
H. Rept. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B.
at 592-593.]
Under 954(d)(1), if a CFC purchases property from a related
person that it sells to any person for use or consumption outside
the country under which it is organized, a U.S. shareholder of
that CFC is subject to U.S. income tax on that stockholder's pro
rata share of the income generated by such sale unless the property sold is manufactured, produced, grown, or extracted in the

- 56 country in which the CFC is organized.

If, however, the CFC

manufactures, produces, grows, or extracts the property that it
sells in the country in which it is organized, the income from
the sale of that property is not foreign base company sales
income, regardless where the property is used or consumed.

Dave

Fischbein Manufacturing Co. v. Commissioner, 59 T.C. 338, 355
(1972); see sec. 1.954-3(a)(4)(i), Income Tax Regs.
Although the terms "manufactured" and "produced" are not
defined by the Code, section 1.954-3(a)(4)(i), Income Tax Regs.,
provides that a CFC will be considered "to have manufactured,
produced, or constructed personal property which it sells if the
property sold is in effect not the property which it purchased."
That regulation further provides that the property sold will not
be considered the property purchased if the provisions of either
section 1.954-3(a)(4)(ii) or (iii), Income Tax Regs., are met.
Section 1.954-3(a)(4)(ii), Income Tax Regs., provides in
pertinent part:
(ii) Substantial transformation of property. If
purchased personal property is substantially transformed prior to sale, the property sold will be treated
as having been manufactured, produced, or constructed
by the selling corporation. * * *
That regulation also includes the following three examples of a
substantial transformation:

(1) Wood pulp into paper, (2) steel

rods into screws and bolts, and (3) fresh fish into canned fish.

- 57 Section 1.954-3(a)(4)(iii), Income Tax Regs., provides:
(iii) Manufacture of a product when purchased components constitute part of the property sold. If purchased property is used as a component part of personal
property which is sold, the sale of the property will
be treated as the sale of a manufactured product, rather than the sale of component parts, if the operations
conducted by the selling corporation in connection with
the property purchased and sold are substantial in nature and are generally considered to constitute the
manufacture, production, or construction of property.
Without limiting this substantive test, which is dependent on the facts and circumstances of each case, the
operations of the selling corporation in connection
with the use of the purchased property as a component
part of the personal property which is sold will be
considered to constitute the manufacture of a product
if in connection with such property conversion costs
(direct labor and factory burden) of such corporation
account for 20 percent or more of the total cost of
goods sold. In no event, however, will packaging,
repackaging, labeling, or minor assembly operations
constitute the manufacture, production, or construction
of property for purposes of section 954(d)(1). The application of this subdivision may be illustrated by the
following examples:
Example (1). Controlled foreign corporation A,
incorporated under the laws of foreign country X, sells
industrial engines for use, consumption, and disposition outside country X. Corporation A, in connection
with the assembly of such engines, performs machining
and assembly operations. In addition, A Corporation
purchases, from related and unrelated persons, components manufactured in foreign country Y. On a per
unit basis, A Corporation's selling price and costs of
such engines are as follows:
Selling price.................................. $400
Cost of goods sold:
Material-Acquired from related
persons........................ $100
Acquired from others.............
40
Total material.................... $140

- 58 Conversion costs (direct labor and
factory burden).......................
70
Total cost of goods sold...............
210
Gross profit................................... 190
Administrative and selling expenses............
50
Taxable income................................. 140
The conversion costs incurred by A Corporation are more
than 20 percent of total costs of goods sold ($70/$210
or 33 percent). Although the product sold, an engine,
is not sufficiently distinguishable from the components
to constitute a substantial transformation of the
purchased parts within the meaning of subdivision (ii)
of this subparagraph, A Corporation will be considered
under this subdivision to have manufactured the product
it sells.
Example (2). Controlled foreign corporation B,
incorporated under the laws of foreign country X,
operates an automobile assembly plant. In connection
with such activity, B Corporation purchases from related persons assembled engines, transmissions, and
certain other components, all of which are manufactured
outside of country X; purchases additional components
from unrelated persons; conducts stamping, machining,
and subassembly operations; and has a substantial
investment in tools, jigs, welding equipment, and other
machinery and equipment used in the assembly of an
automobile. On a per unit basis, B Corporation's
selling price and costs of such automobiles are as
follows:
Selling price................................ $2,500
Cost of goods sold:
Material-Acquired from related
persons................ $1,200
Acquired from others.....
275
Total material............... $1,475
Conversion costs (direct labor and
factory burden)..................
325
Total cost of goods sold.............
1,800
Gross profit.................................
700
Administrative and selling expenses..........
300

- 59 Taxable income...............................

400

The product sold, an automobile, is not sufficiently
distinguishable from the components purchased (the
engine, transmission, etc.) to constitute a substantial
transformation of purchased parts within the meaning of
subdivision (ii) of this subparagraph. Although conversion costs of B Corporation are less than 20 percent
of total cost of goods sold ($325/$1,800 or 18 percent), the operations conducted by B Corporation in
connection with the property purchased and sold are
substantial in nature and are generally considered to
constitute the manufacture of a product. Corporation B
will be considered under this subdivision to have
manufactured the product it sells.
Example (3). Controlled foreign corporation C,
incorporated under the laws of foreign country X, purchases from related persons radio parts manufactured in
foreign country Y. Corporation C designs radio kits,
packages component parts required for assembly of such
kits, and sells the parts in a knocked-down condition
to unrelated persons for use outside country X. These
packaging operations of C Corporation do not constitute
the manufacture, production, or construction of personal property for purposes of section 954(d)(1).
(Hereinafter, we shall refer to the standards of section 1.9543(a)(4)(iii), Income Tax Regs., that the operations conducted be
substantial in nature and be generally considered to constitute
the manufacture of a product as the facts and circumstances test
of that regulation, and we shall refer to the standard of section
1.954-3(a)(4)(iii), Income Tax Regs., that the conversion costs
be equal to 20 percent of the total cost of goods sold as the mechanical test of that regulation.)
Respondent determined that the income for each of the years
at issue from the sale of sunglasses assembled by B&L Ireland and

- 60 by B&L Hong Kong constitutes foreign base company sales income as
defined in section 954(d)(1) that is includible in petitioners'
gross income under section 951(a)(1).

Petitioners argue that

that income is not foreign base company sales income as defined
in that section because the sunglasses assembled by B&L Ireland
and by B&L Hong Kong were manufactured by those companies within
the meaning of section 954(d)(1) and section 1.954-3(a)(4)(ii)
and (iii), Income Tax Regs.
on that issue.
115 (1933).

Petitioners bear the burden of proof

Rule 142(a); Welch v. Helvering, 290 U.S. 111,

We need not address petitioners' contention that the

sunglass assembly operations of B&L Ireland and of B&L Hong Kong
satisfy section 1.954-3(a)(4)(ii), Income Tax Regs.

This is

because we find that those operations satisfy the facts and
circumstances test of section 1.954-3(a)(4)(iii), Income Tax
Regs.

See sec. 1.954-3(a)(4)(i), Income Tax Regs.

Before turning to the application of the facts and circumstances test of section 1.954-3(a)(4)(iii), Income Tax Regs., to
the facts and circumstances established by the record in these
cases, we summarize our views of the experts on whom the parties
rely to support their respective positions (experts) as to
whether the sunglass assembly operations conducted by B&L Ireland
and by B&L Hong Kong constitute the manufacture of sunglasses
under section 954(d)(1) and the regulations thereunder.

- 61 The Experts
Each of the experts prepared an opening report and a rebuttal report, except respondent's expert Joel S. Cohen, Ph.D. (Dr.
Cohen) who prepared only an opening report and petitioners'
expert Irving H. Plotkin, Ph.D. (Dr. Plotkin) who prepared only a
rebuttal report.

Certain of those experts provided additional

testimony at trial.
We evaluate the opinions of experts in light of the qualifications of each expert and all other evidence in the record.
Estate of Christ v. Commissioner, 480 F.2d 171, 174 (9th Cir.
1973), affg. 54 T.C. 493 (1970); IT&S of Iowa, Inc. v. Commissioner, 97 T.C. 496, 508 (1991); Parker v. Commissioner, 86 T.C.
547, 561 (1986).

We have broad discretion to evaluate "the over-

all cogency of an expert's analysis."

Sammons v. Commis-

sioner,838 F.2d 330, 334 (9th Cir. 1988) (quoting Ebben v.
Commissioner, 783 F.2d 906, 909 (9th Cir. 1986), affg. in part
and revg. in part on another issue T.C. Memo. 1986-318.

We are

not bound by the formulae and opinions proffered by an expert,
especially when they are contrary to our own judgment.

Orth v.

Commissioner, 813 F.2d 837, 842 (7th Cir. 1987), affg. Lio v.
Commissioner, 85 T.C. 56 (1985); Silverman v. Commissioner, 538
F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285; Estate
of Kreis v. Commissioner, 227 F.2d 753, 755 (6th Cir. 1955),

- 62 affg. T.C. Memo. 1954-139.

Instead, we may reach a decision

based on our own analysis of all the evidence in the record.
Silverman v. Commissioner, supra at 933.

The persuasiveness of

an expert's opinion depends largely upon the disclosed facts on
which it is based.

See Tripp v. Commissioner, 337 F.2d 432, 434

(7th Cir. 1964), affg. T.C. Memo. 1963-244.

While we may accept

the opinion of an expert in its entirety, Buffalo Tool & Die
Manufacturing Co. v. Commissioner, 74 T.C. 441, 452 (1980), we
may be selective in the use of any portion of such an opinion.
Parker v. Commissioner, supra at 562.

Furthermore, we may reject

the opinion of an expert witness in its entirety.

See Palmer v.

Commissioner, 523 F.2d 1308, 1310 (8th Cir. 1975), affg. 62 T.C.
684 (1974); Parker v. Commissioner, supra at 562-565.
Petitioners rely on the opinions of Douglas E. Nieh (Mr.
Nieh) who was employed by Polaroid Corporation (Polaroid) in its
sunglass business from 1956 through 1988.

His opinions were

based on his experience in the sunglass industry.

We found Mr.

Nieh's opinions to be helpful in resolving the issues presented,
and we rely on them to the extent discussed below in making our
findings and reaching our conclusions herein.
Although respondent does not rely on an expert from the
sunglass industry, she does rely on the opinions of Dr. Cohen, a
licensed optician and an associate professor of Ophthalmic Dis-

- 63 pensing Technology at Cuyahoga Community College.

We have found

that there are significant differences between the assembly of
prescription glasses and the assembly of noncorrective sunglasses.

We did not find Dr. Cohen's opinions to be helpful in

resolving the issues in these cases, and we do not rely on them
in making our findings and reaching our conclusions herein.
Both parties rely on the opinions of engineers.

Petitioners

rely on the opinions of Harry W. Matthews, Jr. (Mr. Matthews), an
engineer employed by Arthur D. Little's Manufacturing and Transportation Industries Section, who had no experience in the sunglass industry.

Although Mr. Matthews concluded that B&L Ireland

and B&L Hong Kong constituted separate manufacturing entities, he
did not address whether the assembly operations of each of those
companies were generally considered to constitute the manufacture
of sunglasses.

We also question some of the facts underlying Mr.

Matthews' analysis.

For example, he concluded that the respec-

tive sunglass assembly operations of B&L Ireland and B&L Hong
Kong involved approximately 65 steps in order to assemble metals,
70 steps to assemble leathers, and an additional 95 steps to
apply leather to metal frames.33

33

He further concluded that the

The number of steps that Mr. Matthews concluded are required
for the assembly of sunglasses does not include a number of
support operations, such as incoming inspections and quality
audits.

- 64 sunglass assembly operations of B&L Ireland involved approximately 75 steps in order to assemble plastics.

Even petitioners

do not argue that the respective assembly operations of B&L
Ireland and B&L Hong Kong involved that many steps.

We did not

find Mr. Matthews' opinions to be helpful in resolving the issues
in these cases, and we do not rely on them in making our findings
and reaching our conclusions herein.
Respondent relies on the opinions of Michael L. Philpott,
Ph.D. (Dr. Philpott), a manufacturing engineer, who, as of the
time of the trial herein, was employed as an assistant professor
of engineering responsible for teaching classes in manufacturing.
Dr. Philpott had no experience in the sunglass industry.

His

opinions were formulated from the perspective of an engineer and
set forth certain hypertechnical views that we do not believe
Congress had in mind when it enacted section 954(d)(1) and that
we did not find helpful to our resolution of the issues herein.
By way of illustration, Dr. Philpott drew subtle distinctions
among the terms "manufacture", "manufacturer", and "manufacturing".

As discussed below, we do not believe Congress had any

such distinctions in mind when it made section 954(d)(1) part of
the Code.
To illustrate further our concerns with the opinions of
Dr.Philpott, he utilized a definition of the term "manufacturer"

- 65 that neither Congress could have intended when it enacted section
954(d)(1) nor the Treasury could have meant when it promulgated
section 1.954-3(a)(4)(iii), Income Tax Regs.

Dr. Philpott opined

during the trial of these cases that, unless a company designed a
product, it could not be considered the manufacturer of that
product if it performed only assembly, and no parts fabrication
operations.

However, he further testified that product design

was not considered part of the manufacturing process during the
early and mid-1960s when Congress enacted subpart F and the
Treasury issued the regulations thereunder.
We also note that Dr. Philpott opined that the assembly of
automobile parts into automobiles constitutes a substantial
transformation of those parts.

That opinion contradicts the view

of the Treasury set forth in example two of section 1.9543(a)(4)(iii), Income Tax Regs., that the assembly of automobile
parts into automobiles does not constitute a substantial transformation of those parts under section 1.954-3(a)(4)(ii), Income
Tax Regs.
In conclusion, we did not find Dr. Philpott's opinions to be
helpful in resolving the issues presented in these cases, and we
do not rely on them in making our findings and reaching our
conclusions herein.
Both parties rely on the opinions of experts who performed
quantitative analyses to determine whether the respective assemb-

- 66 ly operations conducted by B&L Ireland and B&L Hong Kong were
substantial in nature within the meaning of section 1.9543(a)(4)(iii), Income Tax Regs.34

Petitioners rely on the opin-

ions of Gary E. Holdren (Mr. Holdren), a certified public accountant (C.P.A.).
spective.

His analyses were made from an accounting per-

Respondent relies on the opinions of three employees

(viz., Scott D. Hakala, Ph.D. (Dr. Hakala), who holds a Ph.D. in
economics; Martin D. Hanan, who is a chartered financial analyst
and an accredited senior appraiser; and Ray A. Sheeler, who is a
C.P.A.) of Business Valuation Systems (BVS) who prepared an opening report (BVS report) and a rebuttal report.

Although the BVS

report incorporated accounting concepts, it primarily sets forth
economic analyses of the respective assembly operations of B&L
Ireland and B&L Hong Kong.
The respective opinions of Mr. Holdren and the authors of
the BVS report appear to require different conclusions with
respect to the substantiality of the respective assembly operations conducted by B&L Ireland and B&L Hong Kong.

It appears

that at least part of the differences in those opinions is at-

34

Some of the quantitative analyses performed by those experts
related to whether the respective assembly operations of B&L
Ireland and B&L Hong Kong satisfy the mechanical test of sec.
1.954-3(a)(4)(iii), Income Tax Regs. We rely on the facts and
circumstances test of that regulation in holding for petitioners
herein. Consequently, we need not, and do not, consider application of the mechanical test of sec. 1.954-3(a)(4)(iii), Income
Tax Regs., to these cases.

- 67 tributable to the fact that Mr. Holdren's analyses were based on
accounting principles and the analyses in the BVS report were
based primarily on economic principles.

Both accounting and

economic analyses seem to be reasonable and appropriate methods
of analysis for purposes of section 954(d)(1).

Compare sec.

1.954-3(a)(4)(iii), Income Tax Regs., with S. Rept. 1881, supra,
1962-3 C.B. 703, 790.
Nonetheless, we have reservations regarding the respective
analyses performed by Mr. Holdren and the three individuals who
prepared the BVS report.

For example, with respect to Mr.

Holdren, he adopted the classifications that B&L Ireland and B&L
Hong Kong used to classify certain purchased parts as either
direct or indirect materials, rather than making his own independent determinations of such classifications.

Although the clas-

sifications used by B&L Ireland and by B&L Hong Kong are not
necessarily inappropriate for management accounting purposes,
there appear to be different, acceptable methods of classifying
certain types of materials for those purposes.

Petitioners have

not convinced us that the classification method chosen by B&L
Ireland and by B&L Hong Kong, and adopted by Mr. Holdren, is the
most appropriate method for purposes of section 954(d)(1) and the
regulations thereunder.35

35

We also note that Mr. Holdren admitted at trial that he made
(continued...)

- 68 With respect to the three individuals who prepared the BVS
report, in making the analyses reflected therein, they assumed
that the prices that B&L Ireland and B&L Hong Kong paid to B&L
Inc. and that B&L Ireland paid to B&L GmbH for sunglass parts
were not arm's length and that those prices should be estimated
based upon the fair rates of return for the assets used in the
sunglass assembly operations conducted by each of those
companies.

However, reports prepared by respondent's economist

and her examining agent for purposes of determining whether
transfer pricing adjustments should be made for petitioners'
taxable years ended December 29, 1985, through December 27, 1987,
state that the transfer prices paid by B&L Ireland and by B&L
Hong Kong for sunglass parts, which were the same transfer prices
that the parties agreed to use for petitioners' taxable years
ended December 25, 1983, and December 30, 1984, were appropriate
and that no transfer pricing adjustments were necessary.36
The parties have not persuaded us of the reliability and
accuracy of the respective opinions of Mr. Holdren and the three
individuals who prepared the BVS report for purposes of applying

35

(...continued)
an error in the analyses contained in his opening report.
36

We also note that the individuals who prepared the BVS report
admitted that the data that they used in making their analyses
were incomplete and inconsistent, especially with respect to B&L
Ireland.

- 69 section 954(d)(1) and the regulations thereunder.

Except as

stated below, we did not find those opinions to be helpful in
resolving the issues in these cases.

We did not find it neces-

sary or appropriate to rely on questionable, quantitative
analyses of the respective assembly operations conducted by B&L
Ireland and B&L Hong Kong in order to resolve whether those
operations satisfy the facts and circumstances test of section
1.954-3(a)(4)(iii), Income Tax Regs.

Except as noted below, we

do not rely on the opinions of either Mr. Holdren or the three
individuals who prepared the BVS report in making our findings
and reaching our conclusions herein.
To rebut the respective opinions expressed by Dr. Philpott
and the three individuals who prepared the BVS report, petitioners rely on the opinion of Dr. Plotkin, an economist employed by
Arthur D. Little, Inc.

While we found that Dr. Plotkin effec-

tively rebutted those opinions, we generally do not rely on his
opinions because they were provided to rebut the opinions of
experts upon whom we generally do not rely.
All of the experts who prepared opening reports, except Dr.
Cohen, prepared rebuttal reports expressing opinions intended to
refute the opinions expressed in the opening reports of one or
more of the experts relied upon by the other party.

Except for

Mr. Nieh's rebuttal of Dr. Cohen that we found to be helpful in
explaining the differences between the assembly of sunglasses and

- 70 the assembly of prescription eyeglasses, we generally do not rely
upon those rebuttal reports.
Judicial Interpretations of Relevant Regulations
In Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C.
338 (1972), petitioner Dave Fischbein Manufacturing Company
(DFMC) manufactured the parts for portable bag-closing machines37
and assembled those parts into portable bag-closing machines.

It

also sold some of the parts it manufactured to its wholly owned
subsidiary, Compagnie Fischbein, S.A. (CFSA), a Belgian corporation.

CFSA, in turn, assembled those parts into bag-closing

machines.

CFSA did not maintain a sales force, did not design

its own products, and purchased most of the parts used in assembling the bag-closing machines from DFMC.38

Dave Fischbein Manu-

facturing Co. v. Commissioner, supra at 350-351.
Relying on section 1.954-3(a)(4)(iii), Income Tax Regs., we
found on the facts presented in the Dave Fischbein Manufacturing
Co. case that the income generated by CFSA from the sale of the
portable bag-closing machines it assembled did not constitute

37

A bag-closing machine is a type of sewing machine used to
close the mouth of an open bag for products such as animal feed,
seed, fertilizer, and processed food. Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C. 338, 340 (1972).
38

CFSA also purchased from unrelated suppliers some of the
standard parts used in portable bag-closing machines, such as
screws, nuts, and switches. Dave Fischbein Manufacturing Co. v.
Commissioner, supra at 350.

- 71 foreign base company sales income as defined in section 954(d)(1)
because the assembly operations conducted by CFSA were substantial in nature and were generally considered to constitute the
manufacture of property within the meaning of that regulation.
Id. at 359.

The facts on which we relied in reaching those

conclusions included the following:
CFSA (a) tailors and finishes some of its purchased
components in order to place these parts in usable
condition; (b) puts these tailored components and
others together in a 6-hour, 58-step process to form
salable, quality bag-closing machines; and (c) possesses in its plant all of the tools and equipment necessary for these activities. As a result of CFSA's
operations, the purchaser of one of these devices is
guaranteed a carefully put together, well tested, and
operable machine.
*

*

*

*

*

*

*

It was the caliber of CFSA's mechanics which resulted
in a smooth-running operation rather than a lack of
complexity of the operations. [Id. at 360.]
Except for Dave Fischbein Manufacturing Co. v. Commissioner,
supra, no court has had occasion to consider and apply the facts
and circumstances test of section 1.954-3(a)(4)(iii), Income Tax
Regs.

However, on two separate occasions, we considered and

applied certain language in section 1.993-3(c)(2)(iii), Income
Tax Regs., that is similar to the language prescribing the facts
and circumstances test of section 1.954-3(a)(4)(iii), Income Tax
Regs.

Garnac Grain Co. v. Commissioner, 95 T.C. 7 (1990); Webb

Export Corp. v. Commissioner, 91 T.C. 131 (1988).

- 72 Section 1.993-3(c)(2)(iii), Income Tax Regs., is designed to
determine whether a corporation is engaged in the manufacture or
production of a product in the United States for purposes of
section 993, one of the provisions applicable to a domestic
international sales corporation (DISC).

That regulation pro-

vides:
(iii) Operations generally considered to constitute manufacturing. Property is manufactured or produced by a person if the operations performed by such
person in connection with such property are substantial
in nature and are generally considered to constitute
the manufacture or production of property.
"Assembly or packing operations" are not operations generally
considered to constitute the manufacture of property under section 1.993-3(c)(2)(iii), Income Tax Regs.
3(c)(2)(i), Income Tax Regs.

See sec. 1.993-

Nonetheless, judicial interpreta-

tions of language in section 1.993-3(c)(2)(iii), Income Tax
Regs., provide useful guidelines for interpreting the same language in section 1.954-3(a)(4)(iii), Income Tax Regs.

Cf. Webb

Export Corp. v. Commissioner, supra at 142-143.
In the first case in which we considered and applied section
1.993-3(c)(2)(iii), Income Tax Regs., the Webb Export Corp. case,
the taxpayer purchased standing timber and harvested that timber
through a series of operations including felling, delimbing,
bucking, skidding, loading, and hauling the timber.
134.

We found therein:

Id. at 133-

"These various steps, a time-consuming,

- 73 yet time-constrained, process in which petitioner possessed all
the necessary tools and equipment utilized in its logging operations, when combined, constitute a process substantial in nature."

Id. at 144.

We further found that the taxpayer's opera-

tions were generally considered to constitute production.

We

based that finding by considering, inter alia, "how harvesting or
logging is generally perceived in the forest products industry".
Id. at 148.

In that regard, we found, inter alia, that:

(1) Loggers consider themselves to be producers;
(2) standing timber is not particularly useful to
manufacturers; (3) substantial activities are required
before such materials are useful to manufacturers; and
(4) the items considered to be raw materials and who is
perceived to be a producer, varies depending upon one's
position in the manufacturing and/or production process. [Id.]
We again considered the meaning of and applied section
1.993-3(c)(2)(iii), Income Tax Regs., in Garnac Grain Co. v.
Commissioner, supra.

There, the taxpayer purchased grain that it

stored in its grain elevators, processed that grain in a series
of operations including drying, cleaning, aerating, blending, and
fumigating, and sold it for export purposes.

We found that the

taxpayers' operations were substantial in nature because they
required "trained and experienced personnel employing both skill
and judgment in the performance of their duties."

Id. at 28.

However, relying primarily on the fact that the grain industry
considered the taxpayers' operations to constitute grain handling

- 74 or grain merchandising, rather than the production or manufacture
of a product, we further found that the taxpayers' operations
were not generally considered to constitute the manufacture or
production of grain within the meaning of section 1.9933(c)(2)(iii), Income Tax Regs.

Id. at 23-32.

Application of the Facts and Circumstances Test of Section
1.954-3(a)(4)(iii), Income Tax Regs., to the Present Cases
Were the Assembly Operations At Issue
Substantial in Nature?
Petitioners contend that the respective assembly operations
conducted by B&L Ireland and B&L Hong Kong were substantial in
nature.

Respondent disagrees.

To determine whether the respective sunglass assembly operations conducted by B&L Ireland and B&L Hong Kong were substantial
in nature, we must examine the facts and circumstances surrounding those operations.

Sec. 1.954-3(a)(4)(iii), Income Tax Regs.

Respondent contends that those assembly operations were so simple
that they did not require sufficient skill and judgment to rise
to the level of being substantial in nature.

We disagree.

We have found that operators at both B&L Ireland and B&L
Hong Kong required training and experience in sunglass assembly
techniques before they became proficient at assembling sunglasses.

At the B&L Ireland sunglass assembly facility, the

training period for each new operator, which included one-on-one
supervision by a full-time instructor, lasted 13 weeks.

At the

- 75 B&L Hong Kong sunglass assembly facility, new operators also
received extensive training supervised by the assistant production supervisor and group leaders.
During the first few weeks of training, the percentage of
salable sunglasses assembled by a new operator at both B&L
Ireland and B&L Hong Kong was very low.

Even at the end of the

13-week training program at the B&L Ireland sunglass assembly
facility, the typical operator was able to assemble only 70 percent of B&L Ireland's basic target of 200 sunglasses per day.
Although the typical operator at the B&L Hong Kong sunglass
assembly facility was able to achieve the basic daily productivity target of 150 sunglasses per day within four to six weeks
after the commencement of the training program, that person
generally was not able to achieve B&L Hong Kong's average output
of 380 sunglasses per day until some time in that person's second
year of employment.

Not all operators were able to assemble all

SKUs of sunglasses assembled by B&L Ireland and by B&L Hong Kong,
and some operators were not able to reach a sufficient level of
proficiency to continue to function as operators.

At the B&L

Ireland sunglass assembly facility, if an operator began assembling a new style of sunglasses or switched from assembling plastics to metals, the operator underwent additional training.
In addition to the training provided to operators, both B&L
Ireland and B&L Hong Kong provided extensive training to inspec-

- 76 tors, even if those persons had been operators prior to becoming
inspectors.
B&L Ireland's experiences in establishing its sunglass
assembly operations illustrate the need for trained and experienced personnel (including operators, inspectors, and management) to assemble quality sunglasses.

When it first began assem-

bling sunglasses during 1982 and 1983, B&L Ireland experienced a
rejection rate of approximately 80 percent of the sunglasses
assembled by its operators.

To improve the quality of its prod-

uct, B&L Ireland's sunglass operations (1) instituted its own
training program, including hiring full-time instructors beginning in May 1983; (2) underwent a quality audit performed during
1984 by the quality manager of B&L Ireland's contact lens operations in order to develop standard operating procedures; (3) replaced its quality assurance manager shortly after concluding the
quality audit; (4) reduced its expected output in its production
budget for its second year of operation (viz., 1984); and
(5) hired outside consultants during 1983 and 1984 to develop a
job evaluation system and improve the efficiencies of its operations.

Most quality problems at the B&L Ireland sunglass assemb-

ly facility with respect to the basic SKUs tended to disappear
over time as the operators and management became more skillful in
their respective functions and responsibilities in the sunglass

- 77 assembly operations.39
B&L Ireland and B&L Hong Kong relied upon their respective
operators to perform their functions and responsibilities properly.

If those operators had failed to perform them properly, the

sunglasses assembled by those companies would not have met B&L's
quality standards or the appearance and fit expectations of the
ultimate consumers of quality sunglasses.

While some operator

errors, such as failure to make an appropriate adjustment during
the truing process or failure to correct a lens gap problem, were
able to be fixed through reworking the sunglasses, many operator
errors, such as chipped lenses or broken solder on the endpieces,
required the damaged parts to be scrapped and replaced.

As the

operators at B&L Ireland and B&L Hong Kong became more experienced at assembling particular SKUs, the operators became skilled
at reducing damage to the parts and meeting B&L's specifications
for quality.

They tended to learn, for example, (1) how much

pressure to apply to a part in order to bend it without breaking
or otherwise damaging it; (2) how much to adjust the speed and
temperature controls on the heating tunnel in order to make the
plastic fronts sufficiently malleable to insert lenses without
overheating the fronts; (3) how to recognize and correct lens gap

39

B&L Hong Kong also undertook certain actions to improve the
quality problems it suffered during the first year (viz., 1983)
of its sunglass assembly operations.

- 78 problems; and (4) how to overcome problems caused by tolerance
stacking.
To support her position that the respective sunglass assembly operations conducted by B&L Ireland and B&L Hong Kong did not
require substantial skill, training, or experience, respondent
relies on the testimony of Dr. Cohen.

At the time of the trial

herein, Dr. Cohen was a licensed optician and an associate professor of Ophthalmic Dispensing Technology.

Dr. Cohen testified

that he had taught basic assembly of prescription eyeglasses to
students of various levels of education and that it did not
require much time or training for a person to become competent at
assembling eyeglasses.

Dr. Cohen admitted, however, that his

experience related to the dispensing of prescription eyeglasses
through optical shops and that it did not include mass production
techniques.
We are unwilling to rely on Dr. Cohen's testimony to refute
the direct evidence of the training and experience required of
operators at B&L Ireland and B&L Hong Kong in order to assemble
sunglasses that met B&L's quality standards.

It appears that a

person assembling prescription eyeglasses for a retail optical
shop is not required to learn a standard technique for that
assembly.

All that is important is the end result, not the

method utilized to achieve that result.

For example, Dr. Cohen

testified that when students in the Cleveland Job Corps, a

- 79 program in which Dr. Cohen trained nontraditional students in
Ophthalmic Dispensing Technology, including prescription eyeglass
assembly, were learning how to insert lenses into metal frames,
they were given study guides that outlined the materials to be
used and the basic tasks to be performed, and they were allowed
to perform those tasks at their own pace.

Dr. Cohen did not

provide instruction in assembly techniques unless a student was
having difficulty completing the assembly.
While such result-oriented instruction may have been acceptable in a setting such as the Cleveland Job Corps where the
participants were expected to assemble an optimum of 15 to 20
pairs of eyeglasses per week, B&L Ireland and B&L Hong Kong
trained their respective employees to use a standard technique
for sunglass assembly that the operators could repeat several
hundred times per day efficiently and correctly so as to result
in consistently producing quality sunglasses.

Unlike prescrip-

tion eyeglasses that are assembled to fit a particular face and
for a specific prescription, sunglasses must be assembled to fit
a standard face.

Consequently, there is a greater need for

consistent results with respect to the assembly of sunglasses
than with respect to the assembly of prescription eyeglasses.
The use of a standard technique for sunglass assembly allowed
operators at B&L Ireland and at B&L Hong Kong to achieve maximum
output of finished sunglasses that met B&L's quality standards

- 80 with the least damage to the parts occurring during the process.
See Webb Export Corp. v. Commissioner, 91 T.C. at 143.

The

record in these cases shows that it took significant periods of
training and experience for operators to learn the standardized
techniques utilized by B&L Ireland and by B&L Hong Kong to assemble sunglasses ready for sale to the ultimate consumers.

Even

Dr. Cohen admitted that certain problems encountered by B&L
Ireland and by B&L Hong Kong might have been attributable to the
fact that they were mass producing sunglasses, rather than assembling prescription eyeglasses for a retail optical shop.
In addition, the sunglasses assembled at both B&L Ireland
and B&L Hong Kong were inspected at least once by someone other
than the operator who assembled them to ensure that the sunglasses complied with B&L's quality standards.

Dr. Cohen testified

that, at least in Ohio, an optician was required to examine
prescription eyeglasses before they were distributed to the
ultimate consumer.

Although the position of an inspector at B&L

Ireland and at B&L Hong Kong was not the equivalent of an
optician who is licensed and trained to dispense prescription
eyeglasses, the record in these cases establishes that inspectors
at B&L Ireland and at B&L Hong Kong required significant periods
of training and experience in order to perform their jobs properly.

The need for trained inspectors to ensure that the sun-

glasses assembled by B&L Ireland and by B&L Hong Kong met B&L's

- 81 quality standards further demonstrates the substantiality of the
assembly operations conducted by each of those corporations.
Respondent also contends that the assembly operations at
issue did not require a sufficient investment in physical capital
to be substantial in nature.

Although we agree with respondent

that the respective sunglass assembly operations conducted by B&L
Ireland and B&L Hong Kong did not require a large investment in
physical capital, her contention ignores the fact that those
operations required a substantial investment in human capital in
order to produce quality sunglasses.

Without a trained and

experienced workforce, neither B&L Ireland nor B&L Hong Kong
would have been able to produce quality sunglasses that met B&L's
quality standards.

In fact, both B&L Irelan

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A479ee9f12fb7e7d3. Public record. Not legal advice.