T. C. Memo. 1998-461

RECOEDED

SuT.

. T. JUDGh

FILES

T. C. Memo. 1998-461

UNITED STATES TAX COURT

DHL CORPORATION AND SUBSIDIARIES, Petitioners v.

COMMISSIONER OF INTERNAL 1 EVENUE, Respondent

Docket Nos. 19570-95, 26103-95.

Filed December 30,

1998.

Lawrence L. Hoenig, Frank E. Sieglitz, William E. Bonano,

Sarah G. Flanagan, John M. Grenfell, Roderick M. Thompson, Debra

L. Zumwalt, Richard E. Nielsen, Greg L. Johnson, Mark Schallert,

Andrew D. Mastin, Edward M. Prince, Susan T. Brown, and Sheldon

H. Klein, for petitioners.

Mary E. Wynn, Erin M. Collins, Cynthia K. Hustad, Michael J.

Cooper, Kevin G. Croke, Kimberly J. Peterson, and James R. Robb,

f or respondent .

4 08

SERVED

'OEC 3 0 1998

- 2 CONTENTS

Findings of Fact . . . . . . . . . . . . . . . . . . . . . . 4

I.

Background . . . . . . . . . . . . . . . . . . . . . 4

II.

Stock Ownership and Control . . . . . . . . . . . . . 13

III.

IV.

Operating Agreements Between

DHL and DHLI and Related Entities . . . .

Development and Use of the DHL

.

.

.

.

.

.

20

V.

VI.

Trademark and Logo . . . . . . . . . . . . . . . . . 24

Financial Condition of DEL . . . . . . . . . . . . . 31

Negotiations with UPS . . . . . . . . . . . . . . . . 35

VIII.

The Imbalance and Transfer Fees . . . .

VII.

1990-92 Transaction With Foreign

Investors . . . . . . . . . . . . . . . . . . . . . .

. . . . .

.

.

35

58

IX.

Technology and Systems . . . . . . . . . . . . . . 62

X.

Respondent's Determination . . . . . . . . . . . . . 65

Opinion . . . . . . . . . . . . . . . . . . . . . . . . . . 67

I.

II.

III.

Background

67

Unreasonable? . . . . . . . .. . . . . . . . . . . . . 69

The Question of Control . . . . . . . . . . . . . . .

Was There Common Control

After December 7, 1990? . . . . . . . . . . . . .

A.

B.

IV.

. . . . . . . . . . . . . . . . . . . . .

Were Respondent's Determinations

in the Notices of Deficiency

Arbitrary, Capricious, or

Effect of the Trademark Transfer

After the Foreign Investors Attained

Their Collective Shareholding

Majority of the New DHLI/MNV

Entity . . . . . . . . . . . . . . . . . . . . .

Trademark . . . . . . . . . . . . . . . . . . . . . .

A. Ownership . . . . . . . . . . . . . . . . . . . .

Ownership and Value of the DHL

B.

Value of the DHL Trademark . . . . . .

1. Effect of Section 482 Regulations

.

.

.

.

.

77

78

81

83

83

95

on Allocation of Value. . . . . . . . . . . . 120

2.

V.

Respondent's Alternative

Argument--The Alstores

Doctrine

. . . . . . . . . . . . . . . . . . 126

Allocation of DHLI Income to DHL

From Imputed Royalties, Imbalance,

Transfer, and Network Fees for the

Period 197.4 Through 1992 . . . . . . . . . . . . . . 128

B. Royalties .. . . . . . . . . . . . . . . . . . . . 129

C. Imbalance and Transfer Fees . . . . . . . . . . . 135

D. Network Fee . . . . . . . . . . . . . . . . . . - 149

A. Background . . . . . . . . . . . . . . . . . . . 128

VI.

VII.

Are Petitioners Entitled to Setoffs

to Any of the Section 482 Allocations

That Have Been Sustained? . . . . . . . . . . . . . . 152

Section 6662 Penalties . . . . . . . . . . . . . . . 156

Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . 164

- 3 MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge:

Respondent determined deficiencies in income

tax and penalties for petitioners' 1990, 1991, and 1992 taxable

years as follows:

Additions to Tax

Year

1990

1991

1992

Deficiency

$194,534,167

13,912,891

216,139,109

Sec

Sec.

6662(a)

$3,036,446.00

1,599,675.20

1,835,598.00

6662(h)

$71,740,776

2,365,806

82,784,448

In addition, respondent denied timely filed claims for refund by

petitioners with respect to the taxable years ended December 31,

1990, 1991, and 1992, in the amounts of $62,851, $920,991, and

$3,208,934, plus interest thereon, respectively.

The following issues remain for our consideration:

(1) Whether respondent's determinations in the statutory notices

of deficiency were arbitrary, capricious, or unreasonable;

(2)

whether petitioners and certain other entities were commonly

controlled, for purposes of section 482,¹ on or after December 7,

1990;

(3) whether petitioners realized additional capital gain on

the sale of the DHL trademark;

(4) whether petitioners' postsale

retention of a 15-year free domestic use of the DHL trademark

results in capital gain income;

(5) whether petitioners, under

section 482, had additional income frbm forgone royalties;

Unless otherwise stated, section references are to the

Internal Revenue Code as amended and ïn effect for the periods

under consideration. Rule references are to this Court's Rules

of Practice and Procedure.

- 4 -

,

(6) whether petitioners, under section 482, had additional income

attributable to imbalance and transfer fees;

(7) whether

petitioners, under section 482, had additional income from

network fees;

(8) whether petitioners correctly computed their

net operating loss carryover deductions for 1990 and 1991;' (9)

whether petitioners are entitled to setoffs in any year in which

additional section 482 income is finally determined; and (10)

whether petitioners are liable for penalties under section

6662(a) and/or section 6662(h) for taxable years 1990, 1991,

and/or 1992.

FINDINGS OF FACT

I.

Background

Petitioners are DHL Corp.

(DHL or petitioner), formed in

1969 in California, and affiliated subsidiaries.

At the time of

the filing of the petitions in these cases, petitioners'

principal place of business was Redwood City, California.

Petitioner was formed by Adrian Dalsey (Dalsey), Larry Hillblom

(Hillblom), and Robert Lynn, and the first initial of each last

name was used to form the "DHL" name.

Lynn transferred his

interest to Hillblom and Dalsey, each of whom owned 50 percent of

petitioner as of November 1972, and Dalsey retired in 1984, and

his shares were redeemed or transferred to other shareholders.

2 Within the context of this issue, petitioners argued that

for purposes of sec. 382 net operating loss limitations, the

ownership of DHL changed on Dec. 7, 1990. On brief, respondent

conceded this point.

- 5 ,

Petitioner's initial business activity was to pick up and

deliver time-sensitive documents and·small packages by means of

regularly scheduled domestic airline flights between Hawaii and

California.

During 1970, a California corporation was formed to

handle documents and packages between Los Angeles and San

Francisco.

Hillblom recruited John T. Atwood (Atwood) and

William A. Robinson (Robinson) from another courier service to

operate the Los Angeles to San Francisco business, which was

merged with DHL on November 11, 1972, at which time Robinson and

Atwood were each given a 7-percent stockholding interest in DHL.

During 1972, a station was established in Hong Kong and

incorporated there under the name Document Handling Limited,

International (DHLI).

DHLI was incorporated in Hong Kong on

March 14, 1972, and its stock was owned 99 percent by DHL and 1

percent by Dalsey.

Po Chung, a Hong Kong resident, was recruited

by Dalsey to act as DHLI's first manager.

By late 1972 or early

1973, DHL was also offering service through a variety of entities

to Guam, Hong Kong, the Philippines

Japan, Thailand, Australia,

and New Zealand.

The national and international expansion of DHL's activity

was accomplished by employees and/or stockholders going to a new

location to establish an operational system/entity to facilitate

pickup and delivery of documents and small packages to and from

the United States and other locations.

During 1972, Robinson

traveled to Sydney, Australia, and met David Allen (Allen), and

they began a pickup and delivery service there.

Early on,

- 6 -

employees who established the service in some locations accepted

equity interests because of insufficient funds to pay them.

Setting up an international station generally involved the

obtaining of space at the local airport, making arrangements with

the local government customs officials, setting up an office

location, acquiring vehicles, and hiring and training local

managers.

Within a relatively short time, operations were

established in Auckland, New Zealand; Fiji; Jakarta, Indonesia;

Singapore; Kuala Lumpur, Malaysia; Caracas, Venezuela;

Johannesburg, South Africa; and Sao Paulo, Brazil.

The growth of the DHL network, especially in the earlier

years, was attributed to a free-form approach to expansion.

Although a regimen eventually developed, the business expanded

and grew because of the flexibility and freedom of the management

and employees to provide service to customers that comported with

their customs and locality.

After some problems involving the

Civil Aeronautics Board (CAB), operations were divided between

U.S. and international locations.

Even though there was common

shareholder ownership of the U.S. and international corporate

entities, the two operations were allowed to develop separately

in a manner that best suited local expansion and success.

Although DHL and DHLI generally operated separately, certain

physical facilities were operated for their joint benefit, and,

occasionally, the companies used networkwide compensation

incentive plans for their executives.

At executive levels, there

was commonality and "secunding" (sharing) of employees by and

- 7 between DHL and DHLI.

At the shareholder levels, there was

common control of DHL and DHLI.

The companies making up the DHL worldwide network cooperated

through the Network Steering Committee (NSC), composed of DHL

shareholders, senior management, and representatives of the three

principal corporations, DHL, DHLI, and Middlestown, N.V.

The

NSC's purposes were to establish network policies and strategies,

address each company's network right.s and obligations, and

present a uniform organizational image to DHL customers

worldwide.

One of the things that led to the success of the DHL network

was the use of a flat-rate pricing structure, where the customer

was charged a monthly rate for all shipments.

Under this

approach, profit was sought on the consolidation or volume

strategy.

DHL also developed color-coded pouches with

distinctive markings that were known to customers and made

package handling easier and more efficient.

In the early 1970's, one of petitioner's competitors filed a

complaint with the CAB, alleging that petitioner was not just a

courier but also operated as an international air freight

forwarder.

The competitor complaihed that, as a result of the

international freight forwarding, petitioner was required to have

CAB operating authorization, which it did not have at that time.

On April 11, 1972, petitioner filed for CAB interstate and

international operating authorization, and the complaining

competitor objected.

CAB regulations prohibited individuals who

- 8 -

.

were not U.S. citizens from owning more than 25 percent of a U.S.

air freight forwarder.

On May 24, 1973, DHL and Dalsey

transferred their DHLI shares to nominees, ostensibly foreign, of

Po Chung for little or no consideration.

After that transfer of

the DHLI stock, the CAB, on December 19, 1973, authorized DHL's

status as an interstate and international air freight forwarder.

Thereafter, the CAB prohibition on foreign "control" of DHL

was a significant factor in corporate and shareholder decisions

to attempt to keep foreign and domestic activities separate.

Operationally, DHL and DHLI, with limited exceptions, were

autonomously managed by their respective officers, but with a

common commitment to the DHL network.

The exceptions involved

DHL's chief executive officer's responsibilities over DHLI's

Canadian, Mexican, and Latin American operations.

The common

commitment to the network was nurtured by the NSC, consisting of

senior managers representing DHLI and DHL, who met three or four

times a year to exchange information and discuss operational

issues of common interest.

The companies that made up the entir

DHL network were at all times, through September 1992, controlled

by common interests.

In 1974, Hillblom hired Peter J. Donnici (Donnici), a lawyer

and law professor, to represent DHL in the CAB matter.

About

that time, Hillblom asked Donnici to establish a law office in

Donnici's name and to continue to represent DHL.

L. Patrick Lupo

(Lupo), a law student of Donnici's, was employed to assist in the

CAB litigation.

After graduation from law school, Lupo was named

.

general counsel of DHL.

A few years later, Donnici and Lupo

formed a law partnership that eventually became known as Donnici,

Kerwin & Donnici.

DHL was the firm's primary client, and it also

did legal work for DHLI and DHL shareholders.

Donnici became

Hillblom's business and general legal adviser and consultant on

major business decisions.

personal friends.

Donnici and Hillblom were also

DHL, and at one point DHLI, paid expenses of

the Donnici law firm, including rent, overhead, and all salaries.

In the early 1980's, Donnici received DHL shares for his

past work for DHL, a third of which he gave to Lupo for work he

had done.

Donnici was also a director of DHL from the early

1980's until the early 1990's.

While a director of DHL, Donnici

received a retainer from DHLI in the amount of $48,000 per year.

After the transfer of DHLI stock to Po Chung and nominees,

DHLI was used for foreign operations and DHL for domestic.

Operations B.V.

DHL

(Ops B.V.) was incorporated in the Netherlands on

August 13, 1979, as a wholly owned ;subsidiary of DHLI.

When

Robinson and Allen formed the Aust alia station under the name

Document Handling Limited, Australia, Robinson was a DHL employee

who had invested his own funds in

his business.

The business

founded by Robinson and Allen eventually became known as

Middlestown, N.V. , a Netherlands Antilles company (MNV)

incorporated on June 26, 1979.

For most of the period 1974

through September 1992, DHLI, its subsidiary, Ops B.V., and MNV

were the controlling and operational entities of the

international portion of the DHL delivery network.

- 10 -

For the period beginning in 1972 and extending into 1992,

DHL was responsible for handling the courier business inside the

United States, and DHLI was responsible for handling the courier

business outside the United States.

shipments that were:

Each company serviced

Solely within its jurisdiction; from its

jurisdiction that were bound for destinations outside its

jurisdiction; and received from outside its jurisdiction with

destination points inside its jurisdiction.

DHL would also

handle shipments from outside its jurisdiction that were merely

passing through DHL's jurisdiction on the way to another

destination that was outside DHL's jurisdiction.

For shipments to locations outside DHL's or DHLI's territory

or jurisdiction, the documents or packages would be sent to a

"foreign" clearing point of the other company, and they would

then be completely processed by the receiving company.

For

example, if DHL picked up a package in San Francisco that was

bound for a location in Southeast Asia, it would be transferred

to DHLI at one of DHLI's foreign points of entry, and then DHLI

would take responsibility for customs clearance, further

transportation (frequently across international borders), and

delivery to the foreign consignee.

The entity to whom the

customer first submitted the package was paid by the customer and

retained the payment even though another entity delivered the

package.

Accordingly, in the above example, DHL would retain the

customer's payment even though a DHLI/MNV company completed the

delivery.

The worldwide air express service operated by DHL and

- 11 -

.

DHLI was generally represented as, and perceived to be, a single

worldwide delivery system (DHL network) .

In the foreign portion of the DHL network, local operating

companies and independent agents operated under agreements with

DHLI and related companies.

Normally, local operating companies

or agents billed customers an all-inclusive price for shipments

to other service areas.

The local operating companies or agents

normally retained a percentage or pr determined portion of the

revenue received from their customers and remitted the remainder

to the DHLI corporate entities as a "network fee".

Although DHL

was DHLI's pickup and delivery agent in the United States and

vice versa, neither paid a fee to the other, and each was allowed

to retain the full amount charged to the initiating customer

until 1987.

The only exception to this reciprocal arrangement was the

on-forwarding fee that DHLI charged to DHL through the 1986 year

for some 10 destinations in the Middle East and Southeast Asia

because of the great distances from the entry gateways to those

destinations.

The reciprocal no-fee arrangement was allowed to

exist during the 1970's and until 1 86.

been developed to account for each

No specific method had

hipment during that time.

As of 1992, the DHL network extended to approximately 195

countries.

In each of those countries (other than the United

States), pickup and delivery functipns were performed either by a

local operating company that was a ¡corporate affiliate of DHLI or

MNV, or by an independent agent.

Most of the local operating

- 12 -

compana.es were subsidiaries of MNV.

Thus, MNV (through its

subsidiaries) provided pickup and delivery services in many

countries, while DHLI operated the network that linked those

countries together.

As of 1988 the DHL network was, internationally, the third

largest air courier company, with a global market share of about

8 percent, of which somewhat less than 40 percent arose from

outbound shipments from the United States.

Around 1985, a study

reflected that DHL ranked first for international service in the

user samples, and its customer awareness was highest among large

shippers who shipped packages both domestically and

internationally.

A 1986 report explained that DHL had a high

name awareness even though the amount spent to advertise the name

at the time was low.

Although DHLI/MNV (international business)

was growing faster and was more successful during the 1980's, as

of the time of the transactions in question, DHL remained a

important part of the worldwide delivery network.

DHL was

valuable to DHLI/MNV by delivering packages in the United States

and by providing shipments originating in the United States to

the international portion of the network for delivery.

Without

DHL, the DHL network would have had to obtain a delivery agent to

deliver international-origin shipments in the United States and

find new sources of outbound shipments from the United States.

As of the time of the transactions in question, over 20 percent

of the total third-party revenues earned by the DHL network

- 13 -

outside the United States was estimated to be attributable to

DHL.

II.

Stock Ownership and Control

As of December 1, 1989, 77.61 percent of DHL's outstanding

stock was owned as follows:

Consultancy Services Ltd.

Robinson, 9.27 percent.

Hillblom, 46.75 percent; Cheiro's

(Cheiro), 21.59 percent; and W.

The remaining 22.39 percent of DHL's

outstanding stock was owned by other --one of them owning 9.27

percent, and the remainder each owning less than 5 percent.

Cheiro was a Hong Kong corporation, the stock of which was held

50 percent by Allen and 50 percent by Po Chung, from 1977 through

September 1981.

After that time, Cheiro stock was held by Allen

or for his benefit through various entities.

As of the time of the transactions in question, DHLI's stock

was held through Mattawan Ltd.

(Mat awan), a Hong Kong

corporation, which served as an intdrmediate entity.

It was

owned 49 percent each by Po Chung and Hillblom, and the remaining

2 percent was held by the Mattawan Émployees Trust.

MNV's stock

was held 49 percent by Robinson and 51 percent by Allen through

several intermediate entities.

Fro

the relatively early

foundations of DHL, DHLI, and MNV, through the time when the

foreign investors became involved in the DHL network, Hillblom,

Po Chung, Allen, and Robinson, collectively and functionally,

were the controlling shareholders of the DHL network entities and

the DHL network.

Amongst the four controlling shareholders,

Hillblom was the most influential.

- 14 -

In the mid-1970's Donnici introduced Allen to Stephen J.

Schwartz (Schwartz), a tax attorney, who began representing some

of the DHL shareholders and their related entities.

Schwartz'

focus was on the minimization of tax, which, among other methods,

was saved by placing corporate entities in low-tax jurisdictions.

DHLI/MNV, the foreign entities, grew faster than DEL during the

15-year period preceding the 1990 transaction.

Schwartz formed Management Resources International Ltd.

(! RI) in Hong Kong on January 27, 1981, largely for tax reasons.

William Walden, who was hired by and connected to Hillblom, was

placed as head of MRI.

MRI contracted with DHLI, MNV, and DHL to

supervise and coordinate the DHL network, including "(i) the

development of information and advice,

(ii) direction and

implementation of policies relating to marketing, advertising,

operations, electronic data processing, accounting, legal issues

and insurance,

(iii) project research and development, and (iv)

strategic planning."

Before 1989, DHL, DHLI, and MNV used MRI to enhance the

commercial benefits derived from the DHL network.

The NSC also

had oversight of MRI and, in 1989, agreed to its legal

reorganization.

DHL, DHLI, and MNV management reported through

their regions to the NSC's chief executive officer.

By 1988,

more than half of MRI's employees worked in the United States,

and they were covered under DHL's employee benefits package.

DHL

and DHLI periodically advanced funds to MRI to enable it to meet

its costs.

Bedford Management Group, Inc., held 49 percent of

- 15 -

MRI's stock.

At the behest of the DHL shareholders, Schwartz,

Donnici, Lupo, and Charles Lane (Schwartz's law partner) held

equal shares of the stock of Bedford Management Group, Inc.

During 1987, the central management organization was

reappraised, and it was decided that the considerable growth in

the business and increasing competition intensified the need for

a coordinating body that could continue to project and maintain

the DHL worldwide network with uniform operational and service .

standards.

In 1988, DHL established' the Worldwide Coordination

Center (WHQ) in Belgium.

Three superregions were established,

each with its own chief executive officer (CEO). Po Chung was CEO

for the Asia Pacific region; Patrick Foley, DHL's CEO, was CEO

for North and South America; and Robert Kuijpers was CEO for

Europe, the United Kingdom, and Africa.

WHQ was to direct, support, and advise the regions, to

supervise compliance with global policies, and to ensure that the

regions adopted a consistent approach to key issues.

It had

responsibility for establishing str tegy, coordinating resource

allocation, and supporting and advising regional management,

including coordinating with DHL, to ensure that operating

procedures and service levels established centrally or recognized

as best demonstrated practice were used throughout the DHL

network.

A Worldwide Services Depdrtment was also established to

be responsible for directing and coordinating the integration of

operations and marketing initiatives across regions; coordinating

purchased air operations; advancing the worldwide implementation

3

4

- 16 -

of best demonstrated practices in operations, sales, and

marketing; and overseeing the global'accounts program.

Lupo was DHL's general counsel from 1976 through December 1,

1984; CEO for part of 1986; a member of DHL's board of directors

from the early 1980's until 1990 and chairman of its board of

directors from 1985 through September 1986; and from the early

1980's to the time of trial, a minority shareholder of DHL.

In

1985, Lupo moved to England to coordinate the service

requirements of DHL operations in Canada, Mexico, and Latin

America with DHLI and MNV.

Lupo continued in that role until

1988.

From 1986 into 1988, at the request of Po Chung, Lupo

coordinated the activities of DHL, MNV, and DHLI pursuant to an

agreement with DHLI.

Lupo also performed services for MRI.

He

was involved in MRI's 1985 global strategic planning for DHL.

From 1988 until 1992, DHL paid Lupo's compensation and benefits,

but permitted him to serve DHLI.

He performed his coordination

activities as CEO of WHQ beginning in 1988.

In 1990, with the

entry of the foreign investors, Lupo was placed on the boards of

directors of DHLI and MNV.

DHLI provided necessary capital to DHL through Nirada Corp.

B.V., a Netherlands corporation formed for that purpose.

DHL's

domestic expansion during the 1980's was, in part, intended to

increase and protect DHL's international market share.

the operating officers of DHLI were not in favor of the

Although

- 17 -

expansion, DHLI benefited because it was able to offer more U.S.

delivery destinations .to its customers.

On December 7, 1982, Hillblom acquired 49 percent of the

stock of Mattawan, for which he was to contribute $150,000.

At

that time, DHLI had retained earnings of HK$433,521,201

(approximately US$56 million).

Around that time, Hillblom

borrowed or withdrew several million dollars from DHLI, and

through the 1990-92 transactions no interest or principal was

repaid.

Prior to his 1982 acquisitiòn of Mattawan stock, it was

understood that Hillblom had some form of interest in DHLI.

Po Chung also acquired 49 percent of Mattawan's stock, for

which he was to contribute 70 percent of the DHLI stock.

The

employee trust of Mattawan held the remaining 2 percent of its

stock.

On December 20, 1982, Mattawan acquired 120,000 DHLI

shares from DHLI, and on January 24, 1983, Mattawan acquired

49,900 DHLI shares from Po Chung and 99 from Helen Wong.

After

August 8, 1984, Mattawan held all but 1 of DHLI's shares.

In

1989, Schwartz structured a sale of Hillblom's 49 percent

Mattawan interest to Po Chung for US$226 million.

documents were dated December 31, 1989.

The sale

During the transaction

with the foreign investors, petitio er's lawyers advised that the

sale would not be respected for U.S. tax purposes.

On January 15, 1982, the DHL shareholders entered into an

agreement that provided that, in the event of the death of one or

more of them, the deceased's "entire interest in the DHL

business" would be transferred to the surviving DHL shareholders

- 18 -

.

with appropriate compensation to the deceased's estate.

The DHL

shareholders apportioned the net proceeds from the sale of MNV

and DHLI stock in 1990 and 1992, the assets of DHLI and MNV

excluded from the sale, and other assets the DHL shareholders

acquired with funds from DHLI or MNV as follows:

Hillblom

55.4744 percent; Robinson 11.6788 percent; Allen 21.8694 percent;

and Po Chung 10.9774 percent.

The apportionment was not based on

their respective stock ownership and the relative values of MNV

and DHLI.

Instead, it reflected the DEL shareholders' true

economic arrangement.

The DHL shareholders' negotiated

apportionment of the proceeds was premised on the relative

contribution each shareholder had made to the success of the DHL

worldwide operation, although Robinson had made a concession to

Allen to cause the deal to be consummated.

This plan for

apportioning the proceeds was based upon a longstanding agreement

or understanding of the DHL shareholders.

According to the DHLI/MNV shareholders' agreement, Donnici,

Lupo, and Schwartz were to receive $8,437,500, $8,437,500 and

$2,953,125, respectively, from the proceeds of the 1990 and 1992

transactions.

A portion of the DHL shareholders' proceeds was

used to purchase some of the DHL shares of DHL's minority

shareholders.

The DHL shareholders agreed that, for purposes of

determining the amount to be paid for the minority shareholders'

shares, DHL was worth one-third of the total offer for all three

companies.

- 19 -

During the December 1990 through August 1992 period, before

the foreign investors exercised their option, the DHL

shareholders, through and as DHL directors, had veto power over

the following actions by the boards of DHLI and MNV:

(1)

Any change in the employment of Lupo, P. Y. Kuijpers,

Robert Parker, and Errol Gates;

(2)

any issuance of DHL shares or other related securities;

(3)

any debt or lease financing by DHL, with certain

exceptions for refinancings, lease financings below $3 million,

and borrowings totaling less than $5 million;

(4)

any material change to the business of DHL, except for

a reasonable commitment of DHL's resources to development of

heavy freight transportation capability;

(5)

any change in DHL's auditors or accounting policy.

During that same period, among others, the following actions were

subject to supermajority (would require agreement of some board

members controlled by the DHL shareholders) approval by the DHLI

and MNV boards:

(1)

Any amendment to the bylaws and memorandum and articles

of association;

(2)

entering into a new business other than one that was

directly related to the principal business of DHL;

(3)

reappointment of the CEO;

(4)

any debt or lease financing by DHL if, as a result of

such financing, the total amount of debt and lease financing by

DHL would exceed 75 percent of the total capitalization of DHL.

- 20 -

,

The limit was 50 percent if the new investors exercised the

"Newco Share Alternative";

(5)

any matters that exceeded a fair market value of $20

million, including purchases, sales, and leases, and excluding

the exercise of the DHL trademark option.

III. Operating Agreements Between DHL and DHLI and Related

Entities

The responsibilities of individual foreign operating

companies were defined in network operating agreements with DHLI

or Ops B.V, its subsidiary, and the responsibilities of the

independent agents were defined in agency agreements with DHLI

and related entities.

In general, an individual operating

company or agent would bill customers in its service area an allinclusive price for shipments to other service areas.

For

transactions emanating outside the United States, each service

area's operating company or agent typically retained a portion of

the revenue received from its customers and remitted the

remainder to the DHLI entities as a "network fee".

The network fee was intended to compensate DHLI for central

facilities and services--including the air transportation

network, clearinghouse hubs at air terminals, customs clearing

services, know-how, insurance, and advertising--that DHLI

provided for the benefit of the local operating companies and

agents.

Although DHL was DHLI's pickup and delivery agent in the

United States and DHLI was DHL's pickup and delivery agent

outside the United States, with extremely limited exceptions, no

- 21 -

fees or costs were paid for those services exchanged between them

until 1987.

Foreign operating companies and independent agents were

required to use the DHL trademark so as to be identified as part

of the DHL network.

A trademark lic nse was included as part of

the agreements with the local operating companies and agents.

The agreements with foreign local operating companies and agents

generally did not require a separate payment for royalties.

On

occasion, it was necessary to include nominal royalty provisions

in agreements with local operating companies and agents in order

to comply with local law.

Sometimes the royalties were credited

against the network fee.

The network fee remitted to DHLI and

related corporations included payment for the capital

infrastructure, operating expense, know-how, and sometimes a

nominal amount for use of the DHL name provided by the DHL

network.

A memorandum of oral agreement, dated March 15, 1974 (1974

MOA), reflected the agency agreement between DHL and DHLI.

Under

the 1974 MOA, DHLI acted as the foreign pickup and delivery agent

for DHL, and DHL licensed the use of the name DHL to DHLI for the

5-year term of the 1974 MOA.

The 5-year term of the 1974 MOA

could be terminated by DHL on 90 d ys' notice.

Upon termination

of DHL and DHLI's relationship, un er the 1974 MOA, DHLI could

not use the name DHL or any simila

name for a period of 5 years.

Between 1974 and 1990, the 1974 MOA was amended on six

occasions.

The first amendment provided (retroactively to 1974)

- 22 -

that DHL and DHLI were each entitled to the revenues and were

responsible for the expenses related to shipments originating in

their respective service areas.

The first amendment provided a

procedure for selecting an arbitrator to arbitrate any

disagreement concerning the allocation of revenues and expenses.

Both parties consented to the jurisdiction of the U.S. District

Court in Guam to enforce the arbitrator's decision.

On October 12, 1975, DHL and DHLI entered into the second

amendment to the 1974 MOA which, in part, provided that costs and

revenues of the parties' electronic data transmission business

were to be shared as agreed or, if no agreement, based upon

reasonable value of services, reasonable value of resources

contributed, with the understanding that the customers DHLI

served presently were the result of DHL's goodwill.

DHLI again

agreed that it would not use the name DHL or compete with DHL for

5 years after the termination of the agreement.

The second

amendment was for 5 years, and it incorporated and reaffirmed the

terms of the 1974 MOA and the first amendment, including DHL's

right to terminate the 1974 MOA upon 90 days' notice.

The third, fourth, and sixth amendments extended the term of

the 1974 MOA through February 15, 1997.

None of the amendments

changed DHL's right (under the original 1974 MOA) to terminate on

90 days' notice.

The fifth amendment provided that the

relationship or agreement would "remain in full force and effect

unless and until * * * disapproved by the United States

Department of Transportation."

Neither the 1974 MOA nor any of

- 23 -

the six amendments provided for royalties for the use of the DHL

trademark or the DHL name.

In connection with the involvement of the foreign investors,

a December 7, 1990, agency agreement (1990 agency agreement) was

entered into so that the arrangements between DHLI and DHL would

be set forth clearly and completely in one document.

Under the

1990 agency agreement, DHL had the exclusive right to use and

sublicense the DHL trademark in the United States, and DHLI had

the exclusive right to use and sublicense the trademark outside

the United States.

The agreement established reciprocal

performance standards and financial covenants.

Under the 1990

agency agreement, DHL or DHLI would compensate the other, at cost

plus 2 percent, for its shipments in excess of those performed

for the other.

The 1990 agency agreement was terminable only for

cause and had a 15-year term, with an automatic 10-year renewal

if the parties were reasonably satisfied.

It did not contain

DHL's right to terminate the agreement upon 90 days' notice and

it did not provide for DHLI's payment of a royalty for use of the

DHL trademark.

DHL, DHL Airways, a d a newly·created entity, on

August 18, 1992, entered into an ag eement paralleling and

keeping in force the 1990 agency ag eement, essentially

substituting a newly created entity,for DHLI.

Upon termination of the 1990 agency agreement, DHLI would be

prohibited from using the DHL trademark anywhere in the world for

a period of 5 years.

The 1990 agency agreement provided that the

laws of New York governed its interpretation.

It was signed by

- 24 .

DHL and DHLI and filed with the U.S. Department of

Transportation.

In addition to the 1974 MOA and amendments, DHL and DHLI in

their cooperative effort to operate a worldwide DHL network

entered into numerous written and oral agreements.

Some of these

included operational standards such as uniform service criteria

for network performance (percentage of deliveries within an

established time period, data retrieval standards), establishment

of quality of service reporting criteria (systems and measures

for network product volumes, pickup performance, and delivery

performance), service directory format and content, development

of quality control criteria for the network, and development of

global air freight methods for handling larger or traditional air

cargo.

There were also agreements concerning customer service

procedures, methods for taking and handling customer calls,

booking shipments, responding to service requests, dealing with

standard inquiries, managing large accounts, responding to

complaints, and tracking or tracing shipments.

Similar

operational standards existed for the network's ground

operations, gateway operations, and hub procedures.

The 1990

agency agreement, in part, attempted to gather these procedures

and agreements into a single document.

IV.

Development and Use of the DHL Trademark and Logo

During the early development of the delivery network, the

"DHL" name was generally used, but no standard trademark or logo

was used.

In the late 1970's, DHLI commissioned and paid for the

- 25 -

.

design of the first standardized DHL logo, which was then used by

the entire DHL network.

In later ye rs, DHL and DHLI cooperated

on a project to modernize the DHL logo and to develop a Corporate

Identity Manual explaining the use of the redesigned logo, all of

which was cooperatively funded.

Beginning in 1977, DHL began the process of registering the

DHL trademark.

Several different trademarks or logos have been

registered, including "DHL", "DHL Flyer", "DHL Worldwide Courier

Express", and "DHL Worldwide Package Express".

DHL bore the cost

for registering the DHL trademark in the United States.

Ops B.V. and DHLI entered into an agreement on August 13,

1979, stating:

(1) DHL was the "registered proprietor" of the

name "DHL" and used that name in its business in the United

States;

(2) DHLI licensed the name "DHL" from DHL and carried on

business as a document courier on a worldwide basis; and (3)

DHLI, with DHL's consent, appointed Ops B.V. as its agent to

establish and improve the network throughout the world, excluding

the United States.

On November 15, 1980, DHLI and Ops B.V.

executed a "Variation Agreement" modifying the 1979 agreement

with DHL's consent.

Geoffrey Cruikshanks (Cruikshaaks) was hired in 1982 as

legal counsel for the DHLI portion

f the DHL network.

On August

1, 1983, Cruikshanks asked Lupo if DHL would sell DHLI the rights

to the DHL trademark outside the United States.

Lupo responded

that the worldwide rights to the trademark could not be sold

without DHL board of directors and'shareholder approval, but the

- 26 -

.

rights for DHLI to use the trademark only in Central America

could be transferred for $100,000.

DHL transferred the Central

America trademark rights to DHLI for $100,000.

In 1983, Cruikshanks undertook a worldwide registration

program of the DHL trademark.

Although Cruikshanks had been

advised in April 1983 by the DHL general counsel that the DHL

name should be reflected in connection with the registrations

worldwide, that was not done.

Cruikshanks hired John Caisley

(Caisley) to register the trademark.

Caisley was not informed

about the 1974 MOA and DHL's agreement with DHLI concerning the

DHL trademark, and he registered it in DHLI's name in various

foreign countries. Caisley rendered an opinion regarding DHLI's

ownership of the DHL trademark in December 1990 when he was not

yet aware of the 1974 MOA and its amendments.

trademark registrations was borne by DHLI.

The cost of these

DHLI protected the

DHL trademark against infringement outside the United States.

Outside the United States, DHLI also took responsibility and bore

the cost of protecting the DHL trademark, including disputes wit

terminated agents relating to trademark usage.

The DHL name had been protected under U.S. trademark law

since 1969 and the DHL logo since 1977.

From 1978 until 1992,

DHL or its subsidiaries were the registered owners of the DHL

trademark in the United States, and they bore the costs of

obtaining those U.S. registrations.

In July 1986, an employee in

the Argentina office asked a DHL employee for permission to alter

the design of the logo used in Argentina.

An MRI employee was

- 27 -

.

asked to handle the matter, with the request that he direct each

country manager to place next to the ,DHL logo a registration

symbol showing that the logo was a registered trademark of DHL.

In August 1988, DHL learned that the registrations of the DHL

trademark outside the United States failed to reflect DHL's

interest in the trademark and the agreement set forth in the 1974

MOA.

Margaret Phillips, an attorney .in the Donnici law firm, and

Cruikshanks discussed a revised trademark license agreement

between DHL and DHLI setting forth DHL's ownership of the DHL

trademark and the practices and intent of the parties.

Margaret

Phillips drafted an agreement in 1988 setting forth the

understanding that DHL licensed to DHLI the right to use the DHL

name and logo.

The agreement, although unsigned, contains

acknowledgment that DHL owned the worldwide rights to the

trademark and that DHLI obtained trademark registrations to be

held in trust for DHL that DHLI would surrender to DHL upon

042

termination of the license.

The unsigned 1988 agreement was

provided to counsel for the foreig

investors, with the statement

that it represented the agreement

f the parties during due

diligence for the 1990-92 transact on.

As of July 1990, intranetwork memoranda contained the

acknowledgment that DHL owned the worldwide rights to the DHL

name and globally used trademark and trade name.

DHLI was

exclusively licensed to use those marks outside the United States

and, for the sole purpose of complying with trademark laws, could

- 28 .

file trademark applications outside the United States as the

"registered owner".

There was network-wide employee recognition

that DHL was the source of DHLI's use of the trademark rights.

For some period of time prior to 1990, Cruikshanks held the

personal view that DHLI owned the trademark outside the United

States, even though he orally and in writing represented to the

contrary.

During the negotiations with the foreign investors,

questions arose about the trademark ownership outside the United

States because of DHLI's registration of the trademark in

numerous foreign countries.

For purposes of the transactions between DHL shareholders

and the foreign investors, the agreements reflected:

[DHLI] obtains its rights to the DHL trademark from DHL

Corp. and has obtained its.registrations pursuant to

such licence agreement. An unwritten agreement exists

between * * * [DHLI] and DHL Corp. which provides that

upon the termination of the agency agreement between

them, * * * [DHLI] will procure DHL Operations B.V. to

assign all trademark registrations to DHL Corp. without

consideration and at its cost.

The three companies, DHL, DHLI, and MNV, operated in harmony

to protect and·develop the DHL trademark.

In the mid-1980's, a

Corporate Identity Manual was produced, setting forth standards

for the DHL logo's use, including the typeset, colors, and letter

size for each type of use.

DHL's advertising represented to the public that it was one

global delivery company worldwide, and customers were made aware

that their documents could be delivered anywhere in the DHL

worldwide network.

Although advertising was accomplished

- 29 -

,

separately for DHL and DHLI, in the mid-1980's, DHL's management

specifically decided that brand awareness and marketing

strategies should have local focus because the markets served

were too dissimilar to support a global program.

Generally, DHL

or DHLI each bore the cost of advertising for its respective

market.

DHL and DHLI did not directly control the quality of the

goods or services that the other provided.

From 1982 through 1992, DHL spent approximately $150 million

for advertising, publicity, and promotion within the United

States as follows:

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

$6,896,000

12,363,000

14,473,000

. 9,509,000

11,870,000

9,796,302

11,474,000

22,771,452

19,880,000

19,460,000

1992

15,740,000

From 1982 through 1992, DHLI, MNV, and subsidiaries spent

approximately $380 million for advestising, publicity, and

promotion outside the United States as follows:

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

$6,671,000

8,592,000

i 14,933,000

; 24,290,000

32,340,000

34,341,000

37,045,000

48,937,000

47,460,000

56,099,000

70,140,000

- 30 .

The air express business is highly competitive, and

consistency and reliability of service, and to a lesser extent

delivery speed and price, engender customer satisfaction and

loyalty.

In order to provide consistently reliable service, an

air express company must possess and maintain an extensive pickup

and delivery network; an infrastructure of shipment facilities,

planes, vans, and computer systems; tracking technology; and a

great deal of know-how and expertise.

These components are of

greater significance to customers than the name or trademark of

the delivery entity.

Generally, a delivery business' trade name

or trademark will have less value when separated from the

delivery infrastructure.

On occasion, an established delivery

company acquires another operating delivery company solely for

its operating infrastructure, and the acquired company's name is

phased out and/or discarded.

As part of the first stage of the transaction with the

foreign investors, the parties agreed to a reservation of rights

agreement in which an intermediate entity was used to transfer

the DHL trademark to Newco (or DHLI Bermuda) and Elan

Operations B.V.

(Dutchco).

The reservation of rights agreement

provided that nothing contained in it shall be construed as an

assignment or grant to the intermediate entity of legal or

beneficial ownership in or to the trademark, it being understood

that Dutchco is the owner of all right, title, and interest in

and to the trademark in the United States, and that Newco is the

owner of all right, title, and interest in and to the trademark

- 31 -

outside the United States, in each càse subject only to the

rights reserved to the intermediate entity during a so-called

reservation period and thereafter under a license period.

Use of

the DHL trademark by petitioner and its related domestic entities

inured to the benefit of Dutchco and.Newco, and the validity of

trademark ownership was incontestable worldwide.

While the

intermediate entity could grant DHL and DHL Airways the right to

use the DHL trademark in the United States, it could not grant

the right to use the DHL trademark to any other person or entity

anywhere in the world.

In July 1990, there was an agreement in place between DHL

and DHLI providing that, if the transaction with the foreign

investors were terminated, DHLI could not use the DHL name

outside the United States for 5 years.

V.

Financial Condition of DHL

During the 1980's DHL's principal competitors included

Federal Express, United Parcel Serv ce (UPS), and Airborne

Express (Airborne), all of which were larger, had better

economies of scale, and were in better financial condition than

DHL.

In the early 1980's, Federal Express had an 80-percent

share of the U.S. domestic overnight delivery market, and it did

not regard DHL as a significant competitor.

In the early 1980's, however, DHL had 30-40 percent of

the U.S. international outbound market.

Federal Express, which

did not have or offer its own international line of business at

that time, decided to expand into the European market.

Federal

- 32 -

Express did regard the DHL network as the significant competitor

in the European market because of DHL's existing network and

ability to clear customs.

Federal Express failed to build a

successful European delivery network and lost several hundred

million dollars but continued to offer U.S. outbound service.

In 1983, DHL decided to increase its domestic coverage, both

to protect its share of the outbound market and to handle more

domestic shipments that could improve profitability and provide

more potential for foreign outbound customers.

DHLI management,

however, was not in favor of DHL's domestic expansion plan.

DHL's domestic expansion included the establishment of its own

airline (DHL Airways), which was a capital-intensive and

expensive method to ensure expansion capacity and more

individualized and reliable schedules.

There were also additional capital expenditures for new

locations, vans, couriers, and other equipment, which further

strained DHL's cash-flow in the mid-1980's.

Because Federal

Express had an established comprehensive overnight delivery

network, it had achieved the highest volumes and the lowest pershipment costs, and as a result, the DHL expansion was

insufficient to effectively compete.

A bigger company with large

volume and existing ground network, such as UPS, was better

equipped to challenge Federal Express.

DHL bid low on a U.S. Government contract with the General

Services Administration (GSA) to help fill its planes and help

with the extra cost of expansion.

Additional costs, however,

- 33 -

,

were incurred under the GSA contract because the deliveries were

not at consolidated locations but rather were to specific floors,

offices, or désks.

The low bid and added costs made the GSA

contract an additional burden on DHL 041s

financial condition rather

than helping to facilitate expansion

In addition, DHL embarked on its expansion at a time when

the U.S. overnight delivery market was becoming more competitive,

especially because UPS had entered that market.

Federal Express

responded to the market forces by cutting prices, and U.S. market

prices fell steadily during the period when DHL was trying to

expand.

Because of its expansion and the market forces, DHL

experienced increased financial strains and severe cash-flow

problems during the mid-1980's.

From 1983 through 1988, DHL's domestic volume increased

sharply, and its domestic revenues also increased, although at a

lower rate.

Although DHL did achieve some reductions in its per-

shipment costs, the cost of the expansion, price competition in

042

the U.S. market, and DHL's failure to achieve the same economies

of scale as its larger competitors caused DHL to sustain heavy

losses, ranging from $5 million to $25 million per year.

Some of

the reasons for DHL's poor performance in its attempted domestic

expansion were similar to Federal Express' poor performance in

its attempted foreign expansion in attempting to compete with

DHLI.

DHL's losses from 1983 through 1988 were attributable to its

domestic business, not to its outbpund business.

During the same

- 34 -

.

period as the domestic expansion and losses, DHL's outbound

volume and revenues were steadily increasing.

DHL experienced

consistent losses on internal domestic shipments and profits on

its outbound shipments that originated domestically.

In 1986, DHL retained Bain & Co., Inc.

on how to return to profitability.

(Bain), to advise it

Bain analyzed DHL's cost

structure and, in 1987, developed a cost model specifically for

DHL.

Before that time, DHL did not specifically account for cost

data by product line.

Bain demonstrated that DHL's revenue from

an outbound shipment was greater than that from a domestic

shipment, and customer density in a coverage area was extremely

important to profitability.

Bain made recommendations based on

these findings, many of which were implemented and had a positive

impact on DHL's financial performance.

In order to deal with the

increasing debt, financial difficulties, and inability to enlarge

or compete domestically, Bain recommended that DHL consider a

merger with a company in the same industry.

DHL changed its business strategy during 1988, focusing more

on outbound shipments and less on domestic expansion.

The GSA

contract was allowed to expire, more effective cost control

programs were instituted, and by the late 1980's to the early

1990's, DHL started showing profits.

The controlling

shareholders began looking for a suitable company with which to

arrange a merger.

- 35 .

VI.

Negotiations With UPS

From late 1986 through early 1988, DHL and DHLI negotiated

with UPS concérning a potential merger.

UPS was seeking to gain

access to the operational portion of the DHL network outside the

United States.

UPS sought to accomplish that by purchasing all

of the stock; subsequently, however, it focused on a purchase of

the assets of DHLI, MNV, and DHL.

UPS showed little interest in

the DHL trademark, and no attempt was made to value the DHL

trademark for purposes of the negotiations.

It was UPS' intent

to phase in its own name and phase opt the DHL name over a

transitional period extending about 1-3 years beyond acquisition.

In 1987, UPS made a "final offer" of approximately

$330 million for most of the assets of the DHL companies

(excluding certain "carved out" assets that UPS did not wish to

acquire).

UPS did not agree to assume any liabilities in

connection with this offer.

The DHL trademark was included in

the assets that UPS proposed to acquire.

Including the carved-

out assets, UPS' offer would have been approximately in the $450

to $500 million range.

The negotia ions with UPS broke down and

failed primarily because the parties could not agree on price.

VII.

1990-92 Transaction With Foreign Investors

.

On December 21, 1988, a group of foreign investors made

their first generalized offer.

Ultimately, the foreign investors

were Japan Air Lines Co., Ltd.

(JAL), Nissho Iwai Corp.

(Nissho

Iwai), and Deutsche Lufthansa Aktiengesellschaft (Lufthansa).

JAL and Lufthansa are large, partly government-owned airlines.

- 36 -

The foreign investors were interested in integrating their

airline business with the DHL international delivery network.

Initially, JAL and Nissho Iwai were interested in acquiring a

stock and/or asset interest in the DHL network entities,

including the DHL trademark.

After extensive negotiations and

the entry of Lufthansa into the dealings, on December 7, 1990,

JAL, Lufthansa, and Nissho Iwai acquired a 12.5-percent stock

interest in DHLI and MNV, an option to purchase an additional 45percent stock interest to achieve a collective controlling

interest in those entities, and a 2.5-percent stock interest in

DHL.

As of August 18, 1992, the foreign investors exercised

their stock purchase option.

DHL, DHLI, their shareholders, and the foreign investors

were represented in the negotiations by tax, merger and

acquisition, corporate, and other specialized attorneys,

investment bankers, accountants, and advisers.

Hillblom was the

principal shareholder who was most prominent in deciding the

terms in the negotiations with the foreign investors.

The

foreign investors' due diligence investigation was comprehensive

and intensive with respect to the DHL companies' finances,

operations, and assets.

The December 21, 1988, offer was made by two of the foreign

investors (JAL and Nissho Iwai) to purchase up to 80 percent of

the combined DHL network.

The offer did not contain a purchase

price and was conditioned on satisfying the U.S. Department of

Transportation requirement that no more than 25 percent of DEL be

- 37 -

foreign owned.

Counsel for the foreign investors were also aware

that a sale of DHL's assets, including the trademark, for less

than their fair market value could generate legal repercussions

caused by minority shareholders or creditors.

Allen, Po Chung,

Robinson, and Hillblom did not want to divest 100 percent of

their interest in the DHL entities.

Hillblom, in particular,

wanted to continue his interest in the resulting enterprise.

JAL and Nissho Iwai concluded, before making an offer, that

the combined value of DHLI and MNV was $450 million.

Before

determining that value, JAL and Nissho Iwai examined valuations

by independent financial advisers and a market forecast by

Arthur D. Little, Inc.

On June 14, 1989, JAL and Nissho Iwai

sent a letter of intent to the selling shareholders, offering to

purchase not less than 60 percent of the stock or net assets of

DHLI and MNV at a price based on the $450 million value for a

100-percent interest.

The letter of intent indicated that the

foreign investors would not acquire ,an interest in $80 million of

DHL's class B common stock held by

HLI.

The foreign investors retained Coopers & Lybrand (Coopers)

to prepare a report on the DHL operations, including DHL, MNV,

and DHLI.

The report, dated May 31, 1989, was based on

information furnished by employees ànd representatives of the DHL

entities, both through documents and in meetings and interviews.

As part of the report, Coopers advised JAL that if common control

of DHL, DHLI, and MNV existed, the Internal Revenue Service (IRS)

might seek to impute a royalty for DHLI's use of the DHL

- 38 -

.

trademark.

Also, because of concerns about DHL's weak

capitalization and lack of profits, Coopers recommended the

infusion of equity capital into DHL while safeguarding it from

transfer pricing problems.

Coopers stated that no royalty should

be charged DHL for continued use of the DHL trademark and that

such a royalty would make it more difficult for DHL to achieve

profitability.

Coopers also noted that a 2-percent royalty might

be imputed to DHL for its royalty-free license to DELI.

The foreign investors also wanted to ensure that DHL would

continue to be a cooperating and effective component of the DHL

network.

They were also concerned about the possibility that DHL

could experience financial difficulties or could be acquired by a

competitor, and in that regard they wanted to control the DHL

trademark, which they considered to be a valuable strategic

asset.

The DHL network was the main focus of the foreign

investors.

During May 1989, in accord with its advisers'

recommendation, JAL decided not to acquire more than a 20-percent

equity interest in DHL to minimize JAL's exposure to risks,

including those that could occur with respect to U.S. taxation.

The buyers' and sellers' representatives were aware of and

discussed concerns that DHL could be exposed to liability, tax

and otherwise, for royalties due from DHLI for prior use of the

DHL trademark.

It was estimated by the sellers' representatives

that the possibility of an imputed royalty could fall in the

range of 4 to 6 percent of DHLI's annual gross revenues.

- 39 It was at a May 10, 1989, meeting that the sellers'

representatives proposed using the purchase of the DHL trademark

as a vehicle for capitalizing DHL.

It was proposed that any gain

on the trademark sale could be offset by DHL's net operating

losses and that DHL could license the trademark from JAL and pay

royalties, and DHL's taxable income could thereby be reduced.

The foreign investors retained the assistance of an

investment banker, Robert Fleming & Co., Ltd.

(Fleming), and in

February 1989, Fleming prepared a preliminary draft report

concerning valuation.

Fleming placed a value ranging from $600

million to $1.3 billion on the global DHL business, depending on

the methodology.

Fleming also estimated that a prospective

purchaser could expect to pay a premium of 40 to 45 percent to

gain control.

Fleming indicated that the DHL name, while

intangible, does have a value that the vendors would expect to

see reflected in the price.

Fleming also suggested that the

selling shareholders might demand additional consideration for

the value of the DHL trademark in the range of 10 to 15 percent

of the DHLI/MNV stock price.

After a more complete due

diligence, Fleming issued a second report dated June 9, 1989,

which determined that DHLI and MNV had a value in a range from

$392.2 to $680.4 million and that a control premium of 40 percent

of the purchase price was appropriate.

Peers & Co.

(Peers),

which advised JAL, produced its report dated June 9, 1989,

determining that DHLI/MNV had a value ranging from $522 to $580.9

- 40 -

million and that a control premium of 40 to 60 percent of the

purchase price was appropriate.

During December 1989, the foreign investors' objectives were

to gain collective control of DELI and MNV, recapitalize DHL, and

insure DHL's future financial viability.

On June 14, 1989, the

foreign investors sent letters of intent, offering to purchase

the trademark for $50 million, subject to further evaluation by

the parties, and not less than 60 percent of the stock in DHLI

and MNV based on a $450 million value.

JAL recognized that by

owning the DHL trademark it could gain some control over DHL's

activities by including in any license agreement provisions

preventing DHL from engaging in economically irrational conduct.

DHLI would also be protected from DHL's terminating the agency

agreement.

On June 21, 1989, the DHL shareholders advised JAL

and Nissho Iwai, in writing, that although they did not agree to

all the terms in the June 14, 1989, letter,. they remained

enthusiastic, and that further financial negotiations were

necessary.

The DHL shareholders' main concern was price.

JAL commissioned Arthur D. Little, Inc.

(Little), a

consulting firm, to conduct a market study for its negotiations.

Little's March 31, 1989, report projected growth in the small

package sector of the air cargo market between 1987 and 2000,

depending on the geographical market.

During June 1989, Nicholas Miller (Miller) of Coopers, who

was assisting JAL and Nissho Iwai, prepared a rough estimate to

illustrate a conceivable value for the DHL trademark outside the

- 41 -

United States.

Miller arrived at a $25 million estimate, which

was provided to the foreign investors, who considered the

information in their evaluation of the transaction.

In reaching

that estimate, Miller believed that the value of DHL's trademark

rights was diluted by the agreements between DHLI and DHL and

DHLI's rights and use.

Miller's $25 million estimate was based

on the assumptions of $250 million of capital invested and pretax operating profits of $80 million.

He then used a 30-percent

return on capital, or $75 million, leaving a premium of $5

million, which he extended for 5 years to reach a $25 million

estimate.

The foreign investors viewed DHLI as having the right

to use the DHL trademark during the current term of the mutual

agency agreement without additional cost.

In July 1989, Schwartz questioned the impact of the DHL

trademark value on DHL's tax position.

DHL shareholders had

proposed a $100 million value for the trademark.

JAL and Nissho

Iwai decided that they would offer $50 million to DHL for the

dual purpose of purchasing DHL's trademark rights and infusing

capital into DHL.

In their decision to make this offer, JAL and

Nissho Iwai considered DHL's need for capital and had considered

their advisers' reports and advice.

The $50 million offer was

part of a letter of intent to DHL, offering to purchase the

worldwide DHL trademark.

JAL and Nissho Iwai initially thought that the DHL trademark

should be transferred to an entity owned by them, but they were

also agreeable to the DHL trademark's being owned by an entity in

- 42 -

which the selling shareholders retained an interest, if the

sellers bore a proportionate share of the $50 million purchase

price.

On June 21, 1989, the DHL shareholders advised the foreign

investors of their disagreement with some of the terms of the

letter of intent, and the price offered by the foreign investors

was the key issue concerning the DHL shareholders.

After that,

the parties began negotiating a joint venture arrangement where

the DHL shareholders would retain a 40-percent interest in DHLI

and MNV.

Additionally, Hillblom wanted to retain an interest in

the DHL trademark if the joint venture arrangement were

implemented, and he wanted to retain an interest in DHLI and MNV

because of concern about future stock value if he relinquished

control.

During discussions of a joint venture between the DHL

shareholders and the foreign investors in July 1989, the DHL

shareholders advised that they wanted a put with a floor for

their minority share, and they refused to grant JAL and Nissho

Iwai a call on the remaining 40-percent interest, but they were

willing to accept the initial price if they could share in the

benefits of mutual affiliation by deferring the sale of a

significant minority interest and enhance its value.

In July 1989, JAL's and Nissho Iwai's advisers estimated

that at least one-half of DHL's value was attributable to the

agency agreement and the goodwill of the DHL trademark.

In late

August 1989, JAL's and Nissho Iwai's advisers were advising that

- 43 .

unless they increased the purchase price, the transaction would

not be consummated.

On September 14, 1989, Peers produced a revised report,

valuing a 100-percent interest in DHLI/MNV at $625 to $700

million.

In late September 1989, the parties discussed placing

the foreign investors in a supermajority position on the boards

of DHLI and MNV, and other provisions were devised to protect the

DHL shareholders' resulting minority interests against the

foreign investors' collective majority position.

On September 28, 1989, JAL and Nissho Iwai extended an offer

to acquire a 60-percent interest in DHLI/MNV based on a $450

million valuation of those companies,' which was rejected by the

DHL shareholders.

During late September 1989, the DHL

shareholders asked for a price based on values of at least $500

million for the DHLI and MNV stock and $100 million for the DHL

trademark, which the foreign investors rejected.

The DHL

shareholders stated that the parties were so far apart that

further negotiation at that time was useless, and the

negotiations ceased.

The negotiatio1s resumed late in 1989.

Nissho Iwai, without JAL, appro ched the DHL shareholders in

October 1989 to see if they would sell control of DHLI/MNV for a

purchase price based upon a total value for the entities of $670

million.

The DHL shareholders reacted favorably.

to Nissho Iwai's actions.

JAL objected

Also in October 1989, Peers suggested

to JAL that it purchase a 25-percent interest in DHLI/MNV.

Peers

advised that if JAL wanted a controlling interest, it would have

- 44 ,

to increase the purchase price to $650 million for DHLI/MNV and

the DHL trademark with a 1-percent royalty.

On October 19-20, 1989, Hillblom and Mitsuo Ando (a JAL

principal) reached an understanding, which they recommended to

their colleagues, under which JAL would purchase 50 percent of

DHLI/MNV, Nissho Iwai would purchase 10 percent, and the DHL

shareholders would retain 40 percent, based on a $450 million

value of DHLI/MNV to determine the purchase price.

JAL then

advised that it would agree to the above terms only if it

received control of the boards, and Hillblom rejected that offer

JAL then suggested buying, with Nissho Iwai, a 39-percent

interest in DHLI/MNV.

Hillblom believed that for control (51 percent or more) of

DHLI/MNV, the purchase price had to be based on a valuation of

$600 million or more; for less than control, the purchase price

could be based on a valuation of $500 million.

opposed the 39-percent offer.

Allen strongly

Historically, decisions were made

by unanimous vote of the DHL shareholders.

The DHL shareholders,

especially Allen, were concerned that Hillblom was negotiating

without their consent.

On November 7, 1989, JAL and Nissho Iwai offered to purchase

up to 40 percent of DHLI and MNV and the DHL trademark for a

total price based on $500 million, with $50 million for the

trademark.

On November 20, 1989, the DHL shareholders advised

that they would sell 30 percent of DHLI and MNV and the DHL

trademark for a price based on a $500 million valuation.

At that

I

- 45 .

price, the DHL shareholders refused to grant JAL an option to

acquire more shares, and JAL and Nissho Iwai would pay their pro

rata share of the $50 million for the DHL trademark.

Around December 1989, JAL informed the DHL shareholders that

the DHL trademark could be sold for $50 million to an entity in

which the selling shareholders could retain a majority interest.

Another basic understanding was that the foreign investors could

acquire an interest in DHLI and MNV, but no single investor could

acquire more than 50 percent.

About that time, Lufthansa entered

the negotiations, and it was made aware that the price was not

subject to change.

Lufthansa was advised that the $50 million

payment to DHL for the DHL trademark had been set based on DHL's

need for capital.

Lufthansa's counsel understood that the $50

million amount was not based on any appraisal or valuation of the

DHL trademark.

On December 1, 1989, the DHL shareholders made an offer by

which JAL and Lufthansa could each purchase 25 percent of

DHLI/MNV, Nissho Iwai could purchase 7.5 percent, and the DHL

shareholders would retain 42.5 percent.

Lufthansa accepted.

JAL, Nissho Iwai, and

The memorandum of understanding for the sale

of DHLI/MNV shares to JAL and Nissh

Iwai, executed in December

1989, provided for the purchase of shares as stated above (25

percent/25 percent/7.5 percent) at a price based upon. a $450

million value of DHLI/MNV.

DHL would sell the DHL trademark to

the postalliance entity for $50 million, depending on the tax

effect, and receive an exclusive rdyalty-free license for the use

- 46 .

of the DHL trademark in the United States.

The foreign investors

were interested in an asset acquisition to minimize their

exposure to liabilities from DHL's past tax history.

In a

meeting with the DEL representatives during January 1990, JAL and

Nissho Iwai representatives stated that one of their objectives

was to establish a new structure for DHLI/MNV to minimize any

such exposure.

Also, in a January 1990 meeting among the

parties' representatives, the issue arose of whether the

trademark sale could be considered a sale for $50 million plus

the value of the 15-year royalty-free period, which could

constitute additional income to DHL (the Alstores problem).

On February 23, 1990, the parties drafted a supplement to

reflect the addition of Lufthansa to the transaction.

First

Boston Corp., investment bankers retained by Lufthansa, valued

DHLI/MNV at $400 to $600 million.

It valued the DHL trademark at

$100 to $200 million.

The foreign investors initially understood that DHL owned

all rights in the DHL trademark throughout the world.

As their

due diligence progressed, however, they became aware of certain

inconsistencies, including the registrations of the DHL trademark

in DHLI's name throughout the world.

The foreign investors never

resolved these inconsistencies concerning the DHL trademark.

Ultimately, it was agreed that, if the foreign investors

exercised their stock purchase and trademark options, DHL would

transfer all its rights in the trademark, including those it may

have within and without the United States.

- 47 DHL's lenders consented to a trademark option agreement, but

only on the conditions that:

(1) DHL would "receive full value

(as determined on an arms length-transaction basis) for the

assets it transfers pursuant to * * * [that] Agreement";

(2) DHL

would receive at least.$50 million as consideration for the DHL

trademark or as additional equity investments; and (3) DHL would

receive a 15-year royalty-free license to use the DHL trademark.

After the 15-year royalty-free period, DHL would have to pay .75

percent of its gross sales as a royalty for use of the DHL

trademark.

In a communication dated as late as May 10, 1990,

DHL's legal representative was representing to the lenders that

DHL owned the trademark and licensed it to DHLI.

At a time when the total price for the transaction had been

fixed and the amounts to be allocated or assigned to various

aspects were being negotiated, the foreign investors'

representatives were concerned about the bona fides of the

transaction and that the amounts assigned to various assets were

properly determined for tax purposes.

There was concern that the

focus had been on a $50 million cash infusion into DHL and not on

the price, value, and/or tax attribdtes of the trademark aspect

of the sale.

The DHL shareholders and their|representatives were

concerned about the tax implications of selling the United States

and worldwide rights to the DHL trademark.

DHL's representatives

expressed the wish to the foreign investors' representatives that

the amount received for the trademark be minimized.

One

- 48 -

.

suggested approach to accomplish that was to form a Dutch holding

company.

The new entity would transfer the foreign DHL trademark

rights to the holding company after purchasing them from DHL for

$10 million in return for a majority interest in the holding

company.

DHL would also transfer the domestic DHL trademark

rights to the holding company in return for a minority interest.

The foreign investors did not agree to this approach, but they

would consider a new or other proposals.

Detailed and protracted

negotiations ensued among the parties' legal representatives, and

several alternatives were proposed and discussed.

On March 23, 1990, Hillblom met with JAL and Lufthansa

principals to restructure the transaction into two steps.

In the

first step, JAL and Lufthansa would each purchase a 5-percent

interest in DHLI/MNV, and Nissho Iwai would purchase a 2.5percent interest.

JAL and Lufthansa would each be granted an

option to purchase up to 25 percent of DHLI/MNV, and Nissho Iwai

would be granted an option to purchase up to 5 percent.

DHLI

would be granted an option to purchase the DHL trademark,

exercisable when the foreign investors exercised the option to

purchase the additional DHLI/MNV shares.

The foreign investors

would receive current board representation based upon the number

of shares they would own after the options were exercised.

On April 20, 1990, DHL's representative presented a

structure to the foreign investors for the transfer of the DHL

trademark in an attempt to minimize the tax effects.

The

original memorandum of understanding set a price of $50 million

- 49 for the DHL trademark, and under the proposed structure the

foreign investors would contribute $28.75 million and the DHL

shareholders would contribute $21.25 million.

DHL's

representative proposed the following structure:

before the

execution of a binding contract of sale between DHL and the

foreign investors, the current agency agreement would be extended

for 15 years, including the royalty-free license to DHLI; in the

new agency agreement DHL's right to terminate at will would be

eliminated; and upon DHLI's exercise of its trademark option, DHL

would sell to DHLI an interest in the non-U.S. rights to the DHL

trademark.

DHL would also sell to DHLI the U.S. rights to the

DHL trademark, to be encumbered by the 15-year royalty-free

license to DHL.

Both royalty-free licenses, as well as the

elimination of DHL's right to terminate the agreement at will,

could reduce the value of the DHL trademark sold by DHL.

The

value of the rights sold was to be determined by an appraiser but

would be valued as encumbered.

The transfer of the DHL trademark

from DHL to DHLI followed this basic structure.

On April 27, 1990, DHL's.representative indicated that an

appraisal of the DHL trademark would have to be obtained in order

to set the exercise price.

Because the transaction was taxable

to DHL, the representative did not want the exercise price to

exceed fair market value, and he noted that the DHL trademark

would be encumbered at the time the option was granted by

reciprocal long-term royalty-free licenses to DHLI and DHL, and

the trademark should therefore be diminished in value.

- 50 -

.

The July 9, 1990, trademark option agreement provided that,

upon exercise of DHLI's option to purchase DHL's trademark .

rights, DHL would "retain an interest in the [DHL] Trademarks in

the form of a fifteen-year royalty-free license to use the

Trademarks in the United States".

At the time the trademark

option agreement was signed, the parties were still working on a

form of trademark license.

Although there were drafts of a

trademark license agreement and negotiations concerning a license

agreement, no trademark license agreement was ever executed by

the parties.

Ultimately, the parties entered into a reservation of rights

agreement, dated as of September 17, 1992, under which a DHL

company ultimately conveyed:

(1) The U.S. rights in the DHL

trademark to Dutchco, a Dutch subsidiary of DHLI Bermuda; and

(2) the non-U.S. rights in the DHL trademark, to the extent that

DHL or DHL Airways owned any such rights, to DHLI Bermuda

(Newco).

Pursuant to that agreement, DHL retained the right to

use the DHL trademark in the United States without payment of

royalties until September 17, 2007, and if the 1992 agency

agreement was renewed, Dutchco would give DHL an exclusive

license to use the DHL trademark in the United States for 10

years, at a royalty of .75 percent of gross sales.

The selling shareholders arrived at a $20 million value on

DHL's trademark rights.

The parties agreed that Bain, who was

familiar with DHL and DHLI from prior engagements, would do the

appraisal.

- 51 -

DHL' s legal representative in the transaction was

responsible for obtaining the valuation of the DHL trademark from

Bain.

Bain stated that it was asked to value the DHL trademark

on the assumption that it would be conveyed to Newco on a 10-year

royalty-free basis.

the value.

On May 21, 1990, Bain began its analysis of

On May 23, 1990, 2 days after Bain began its

valuation of the DHL trademark, it sent a draft letter stating

that Bain could provide some comfort' on the issue before it and

that the 1990 value of the right to the DHL trademark in the

United States 15 years after the transaction was $20 million.

DHL's legal representative noted that Bain should value both U.S.

and the -foreign rights to the DHL trademark and that they should

be valued currently but as encumbered by the 15-year royalty-free

license of the international rights from DHL to DHLI and the 15year royalty-free license of the U.S. rights from DHLI to DHL.

Petitioner's representatives had some doubt about

Cruikshanks' view that DHLI owned the foreign rights to the DHL

trademark.

In a July 3, 1990, memo andum to Bain, DHL' s legal

representatives explained DHLI's potential ownership rights in

the DHL trademark and Cruikshanks' view that DHLI owned the

foreign rights to the DHL trademark.

Bain's valuation took into

consideration DHLI' s possible ownership rights.

Bain appraised

the trademark rights to be conveyed from DHL to DHLI at' $20

million as of July 9, 1990.

There is some confusion as to

whether Bain' s valuation is a current value or a present value of

a future interest.

- 52 The trademark option agreement gave DHLI an option to

purchase the trademark rights of DHL only if the foreign

investors first acquired a controlling interest in DHLI.

The

final trademark purchase and sale agreement, dated as of

September 17, 1992, allocated the $20 million option price at $17

million for the transfer of certain U.S. trademark rights to

Dutchco, subject to the reservation of rights agreement, and $3

million to a quitclaim of DHL's interest in the non-U.S.

trademark rights in favor of Newco.

The overall transaction with the foreign investors was to

occur in two phases, so that the foreign investors would

initially have a minority of the shares with control of 7 of the

13 seats on the boards of DHLI and MNV in order to learn more

about the DHL network and consider the operational synergy before

deciding to acquire majority interests in DHLI and MNV.

JAL and

Lufthansa could each appoint three board members, and Nissho Iwai

was entitled to appoint one board member.

The remaining six

members of the board were to be appointed by the DHL

shareholders.

The number of board members to be appointed by the

foreign investors was dependent upon whether each of them

exercised its option to acquire additional ownership in DHLI/MNV

in the second phase of the transaction.

The foreign investors

were also entitled to appoint 2 of the 11 board members of DHL,

the remainder being appointed by the DHL shareholders.

Under a

share pledge agreement, dated December 7, 1990, Po Chung,

Robinson, Hillblom, and Allen and/or their entities holding stock

- 53 .

on their behalf, pledged their DHLI and MNV stock holdings to

secure their obligations and liabilities to the foreign

investors.

On December 7, 1990, under the amended share purchase and

option agreement, the foreign investors acquired 12.5 percent of

the stock of DHLI and MNV for $53,125,000 in cash and 2.5 percent

of the common stock of DHL for $3,125,000 in cash.

The

$56,250,000 combined purchase price represented 12.5 percent of

$450 million, without considering the $3,125,000 allocated to the

DHL stock.

Of the 12.5-percent stock holdings- in DHLI and MNV,

JAL was to receive 5 percent, Nissho Iwai 2.5 percent, and

Lufthansa 5 percent.

There was no assurance in December 1990,

however, that the foreign investors would exercise their options

to acquire a controlling interest in DHLI when they acquired

their initial 12.5-percent interest in DHLI and MNV.

If the

foreign investors had not been able to, or had chosen not to,

exercise their option to acquire a ¾ontrolling interest in DHLI

and MNV, they would have had no right to recover the money they

paid for their initial 12.5-percent interest in DHLI and MNV.

In the second phase of the transaction, the foreign

investors had an option to purchase, in similarly divided

portions, an additional 45-percent interest of DHLI and MNV (for

45 percent of $450 million or $202,509,000).

The foreign

investors also had the Newco alternative, involving the

reorganization of DHLI and MNV into a single entity.

Under the

Newco alternative, each of the foreign investors would contribute

- 54 ,

the difference between the amount already paid for the 12.5percent interest and an amount that would give JAL and Lufthansa

a 25.001-percent interest and Nissho Iwai a 7.5-percent interest

in Newco.

DHLI would contribute, with certain exceptions, all

its assets to Newco, the MNV shares would be contributed to

Newco, and Newco would transfer its remaining 42.498 percent of

its shares to the DHL participants, which included the

controlling shareholders of the DHL network.

The net economic

result of the DHLI/MNV or Newco options was substantially

identical, and in either event the foreign investors would

provide $283,634,000 in cash and obtain a 57.502-percent interest

in DHLI/MNV.

Ultimately, the Newco approach was used, and its

structure and the entities involved were changed several times

before the transaction was consummated, but the net economic

effect remained the same as outlined above.

An August 18, 1992,

agreement contained the final version of the Newco transaction,

and its terms are outlined, along with a diagram to show the

steps, in the appendix to this opinion.

As of June 7, 1992, the foreign investors exercised their

option to use the Newco alternative to acquire the assets of DHLI

and MNV subject to the liabilities of each entity.

Thereafter,

the foreign investors, together, owned a majority (57.5 percent)

of the stock of DHLI Bermuda (the successor to DHLI and MNV) and

collectively appointed a majority of its board of directors,

which governs by majority vote.

On September 17, 1992, DHL's

assignee, conveyed to Newco DHLI's interest in the non-U.S. DHL

- 55 -

,

trademark.

The board of directors of Newco was to be composed of

six members, of whom one would be appointed by JAL, a second by

Nissho Iwai, a third by Lufthansa, and a fourth by the DHL

shareholders.

The remaining two directors were to be appointed

by vote of the other four directors.

The JAL and Lufthansa

directors were each entitled to three votes; the Nissho Iwai

director, one vote; the DHL shareholders' director, five votes;

and the resident directors, one-half vote each.

Around the time the second phase of the transaction was

being completed, DHL's representatives became concerned about a

tax-related issue denominated the "Alstores problem" because of

the holding in Alstores Realty Corp. v. Commissioner, 46 T.C. 363

(1966).

To avoid the problem, DHL'

representatives proposed

several alternative approaches to conveyance of the DHL

trademark.

Each alternative involved the present conveyance of

non-U.S. rights and the retention of U.S. rights to the trademark

by DHL for 15 years with a mechanism that permitted DHLI to

obtain ownership of U.S. rights if DHL did not maintain certain

minimum net worth requirements or on the happening of certain

other events.

Each alternative con emplated payment of $20

million, even though complete transfer of U.S. rights was not to

be for 15 years.

One of the foreign investor's representatives,

responding in the negative to the proposal, explained that the

transfer of the trademark was to protect the right and interest

of the foreign investors from unexpected situations, such as a

takeover of DHL by its competitors.

He further advised that the

- 56 -

.

foreign investors had no inclination to accept any of the

alternatives proposed unless it not only satisfied the DHL

shareholders' request to save taxes on DHL but also protected the

foreign investors.

Another representative of the foreign investors rejected the

proposal and noted that the foreign investors expressed their

willingness to be flexible in considering adjustments to the form

of Newco's ownership if such adjustments would assist DHL in its

tax planning without sacrificing a key element of the business

deal.

During the period December 1990 to August 1992, the foreign

investors occupied their positions on the boards of DHLI and MNV

and acted in the roles of directors.

The management of DHL,

however, was maintained with the staffing that it had prior to

the 1990 transaction.

The foreign investors did not participate

in the day-to-day management of DHLI and MNV in that period,

although an employee of JAL and, on occasion, a few employees of

Lufthansa worked in the Brussels office.

There was also an

Executive Committee of the board, consisting of one director

appointed by each of the foreign investors and of the DHL and

DHLI CEO's.

The Executive Committee's purpose, however, was to

implement decisions of the board.

The reservation of rights agreement (:RORA) reserved to

petitioners the exclusive right to use the trademark in the

United States in the door-to-door package delivery business for

15 years, subject to:

(1) Quality control provisions; (2) a

- 57 .

termination clause that provided for termination if the agency

agreement was terminated;

(3) petitioners' exercising reasonable

diligence to prevent infringement; and (4) prompt notice of

infringement.

Petitioners had no right to decide whether to

bring an infringement action.

If an infringement action was

brought, petitioners had to cooperate completely, had to

prosecute the action, and had to bear the cost thereof unless

Dutchco elected to control the action.

Petitioners further

covenanted that they would use their best efforts to promote the

trademark, that they would not register any of the trademarks or

any similar trademark in the United States or any other nation,

and that they would not use the trademark of any competitor or

use the DHL trademark in any way not authorized by the RORA.

The RORA imposed quality controls on DHL's manner and use of

the trademark, and DHL could be required to change its manner and

use.

After the RORA was executed, DHLI decided issues relating

to the use of the DHL trademark.

The RORA granted petitioners a

license to use the DHL trademark for 15 years royalty free.

After the 15-year period, the RORA

alled for a royalty of .75

percent of DHL's gross sales for it

delivery business.

Of the

$20 million price for the DHL trad mark, representatives for DHLI

and DHL allocated $17 million to the U.S. rights and $3 million

to the non-U.S. rights.

- 58 -

VIII.

The Imbalance and Transfer Fees

DHL shipments of domestic origin to foreign destinations to

be delivered through DHLI were termed "outbound" shipments.

DHLI

shipments of foreign origin to domestic destinations to be

delivered by DHL were termed "inbound" shipments.

Shipments of

foreign origin with foreign destinations, but which passed

through the United States and were handled by DHL, were termed

"transfer" or "transit" shipments.

Before 1983, actual imbalances of shipments were not tracked

or reported by either DHL or DHLI/MNV.

In December 1983,

however, the DHL board recognized the need to examine the ratio

of U.S. inbound to outbound deliveries, as well as the need for

further study of the allocation of air transportation costs for

on-forwarding of international shipments between U.S. points and

a comparison of corresponding international on-forwarding of U.S.

shipments.

Before 1987, neither DHL nor DHLI was compensated if

the outbound or inbound shipments exceeded one another.

Likewise, before 1987, DHL received no compensation for handling

transfer shipments.

In a 1988 amendment to the 1974 MOA, provision was made for

a cost plus 2 percent compensation on the imbalance of shipments

(imbalance fee).

DHL's system of determining imbalance shipments

and applying cost plus a percentage markup was modeled after the

system used by postal authorities throughout the world.

The

imbalance fee was implemented for the taxable year 1987 and

forward, although only costs were paid for 1987.

The imbalance

- 59 -

fee was calculated by netting the inbound and outbound shipments

and applying the cost plus 2 percent imarkup to the difference.

The imbalance cost factor was each cdmpany's average cost of

delivery of packages of any weight and size within its respective

territories, determined annually.

The imbalance fee was

calculated using shipment units without considering the weight of

any particular shipment.

In 1987, the U.S. Department of'Transportation (DOT)

questioned whether the memorandum of agreement, as it existed

before 1987, adequately compensated DHL for the services

performed by DHL for DHLI/MNV.

During due diligence for the 1990

and 1992 transactions, DHL management expressed doubt that the

cost plus 2 percent markup adequately compensated DHL for its

services to DHLI/MNV.

Coopers also questioned whether the cost

allocation system accurately reflected the costs incurred by DHL

in delivering shipments for DHLI/MNY.

On average, more than one-third of the DHL network's

international shipments emanated from or were delivered in the

United States, not including shipments that DHL transferred for

DHLI/MNV in transit from one foreign locale to another.

The DHL cost information model

used to calculate the

imbalance fee and the transfer fee were developed by Bain in 1987

and were denominated "Product Line Profitability"

(PLP) models.

DHLI also employed a model that was developed by Bain in 1989.

Based on available data for the years 1984 through 1986 (before

development of PLP), it was determined that DHLI suffered an

- 60 -

,

imbalance of 65,000 shipments in 1984, an imbalance of 496,000

shipments in 1985, and an imbalance of 333,000 shipments in 1986.

The net imbalance of shipments for 1987 through 1992 was as

follows:

DHLI ' s

DHL ' s

Shipments

In Excess

Shipments

In Excess

Year

of DHL's

Of DHLI's

1987

1988

1989

1990

1991

1992

452,439

458,423

343,342

18,774

-----

--------162,746

212,127

For 1989 through 1992, the following table shows the reconciled

shipment imbalances between DHL and DHLI:

DHLI's or

(DHL's)

Shipments from

Shipments from

Net

Year

DHL to DHLI

DHLI to DHL

Imbalance

1989

1990

1991

1992

5,795,812

6,742,804

7,155,582

7,888,518

6,139,154

6,761,578

6,992,836

7,676,391

.343,342

18,774

(162,746)

(212,127)

.

Shifts in the imbalance were expected at the time the imbalance

fee formula was negotiated.

The imbalance suffered by DHLI grew each year from 1991

through 1996.

The imbalance fee negotiated between DHL and DHLI

and included in the 1988 agency agreement was used in the 1990

and 1992 agency agreements, after the foreign investors became

involved in DHLI, and continued through the time of trial.

A costing model (with the acronym "PRISM") developed by Bain

for DHLI is used for pricing, budgeting, and planning purposes

- 61 and is also used in the imbalance fee calculation between DHLI

and DHL.

For 1991, DHLI computed its per-unit cost of delivering

documents and dutiable parcels from DHL at $10.59 and $30,

respectively.

For 1992, the document and dutiable parcel

delivery costs were $10.49 and $28.70, respectively.

The actual weighted average costs, including the 2-percent

markup used by DHL for 1990 and DHLI for 1991 and 1992, were

$10.19, $15.25, and $15.25, respecti ely.

e

The 1988 amendment

also provided for a cost plus 2 percènt payment to DHL for its

cost of handling transfer shipments.

DHLI paid this transfer fee

to DHL, and DHLI did not perform a similar function for DHL.

Before 1987, DHL paid a fee to DHLI for delivery of outbound

shipments to certain remote or highep cost destinations (onforwarding fee).

The on-forwarding fee was charged to DHL to

cover DHLI's cost of delivering shipments from the first

international gateway to approximately 10 remote or higher cost

destinations.

The transfer cost factor was cQmputed annually as DHL's

average cost of handling a transfer shipment.

For 1987, DHL

received its costs without the 2-percent markup for the transfer

shipments.

The on-forwarding fee was eliminated after 1986.

The

transfer fee was determined by multiplying the estimated number

of transfer shipments by DHL's average cost of handling such a

shipment, and (beginning in 1988) by adding a 2-percent markup to

average cost.

Before 1987, DHL and DHLI/MNV did not employ any

method to determine the average cost per shipment or the volume

- 62 of transfer shipments.

From 1987 through 1990, the cost data

used in the transfer fee formula were taken from the PLP model.

The shipment volumes used in the transfer fee formula were

not readily available when the transfer fee was instituted

because DHL did not focus on how shipments were routed.

To

determine percentages of transfer shipments for 1987 and 1988,

the number of transfer shipments was estimated by counting

shipments originating in or destined for a Latin American

country, Mexico, and/or Canada, with appropriate adjustments, and

interviews with gateway managers.

For 1989, the number of

transfer shipments was estimated by taking a percentage (based on

1987 and 1988 data) of international inbound shipments.

Annual

transfer shipments for 1990 were estimated by sampling transfer

shipments for 1 week, calculating a daily transfer shipment

volume, and applying the percentage of daily transfer shipment

volume to total annual Western Hemisphere shipments.

The same

procedure was used for 1991 as had been used in 1990, but using a

2-week sampling.

A more refined transfer shipment cost

calculation was devised for 1991.

The transfer fee was carried forward in the 1990 and 1992

agency agreements after the foreign investors became involved in

DHLI.

IX.

Technology and Systems

Generally, DHL and DHLI each developed its own technology

and systems.

Several software applications, however, developed

by or for DHLI were adapted and used by DHL, and DHL sold DHLI

- 63 -

rights to certain laser technology in 1984.

The sale price was

$14.5 million, consisting of $10 million for the technology

rights and $4.5 million for technical services.

The technology

had been developed between 1982 and 1984 by NetExpress, Inc.

(NetExpress), with funding from DHL., DHLI did not use the laser

system in its original form; instead, it was used after

modifications.

The major reason for the sale of the laser

technology was to raise capital for DHL during a period of acute

financial problems.

In addition to the technology that DHL and DHLI each

developed for its own use, certain shared technology was

developed to enable DHL and DHLI to exchange information

electronically.

Beginning in 1987, DHL and DHLI each paid for

this shared technology service on a cost plus 10 percent basis.

This shared technology was developed during the period 1982-92 by

three companies:

NetExpress;

MRI, which managed the "Global

MIS" group; and DHL Systems, Inc.

(DHL Systems).

The Global MIS group of MRI wa

formed in 1986.

In 1987 and

1988, MRI/Global MIS was paid for m nagement information services

by DHL and DHLI in proportion to DHL's and DHLI's respective

gross revenues, except for certain communications and other

costs, which were paid on the basis of actual services.

The

management information services and technology functions

performed by MRI were taken over by DHL Systems in 1989.

During

the years 1989-92, DHL Systems was paid for its services pursuant

to an agreement between DHL and DHL

whereby DHL Systems was

- 64 .

reimbursed for its costs in amounts proportionate to DHL's and

DHLI's respective gross revenues, except where the anticipated

benefits from particular projects could be allocated according to

specific anticipated usages.

This method of cost allocation was

not changed with the advent of the foreign investors in 1990 or

1992.

From 1986 through 1992, $178 million was expended for

shared technology, consisting of approximately $40.5 million by

DHL and $137.5 million by DHLI, or in a 22.8 percent to 77.2

percent ratio.

NetExpress was incorporated in 1982 as an 80-percent-owned

subsidiary of DHL.

NetExpress had operated at a deficit, and in

1985 DHL sold to DHLI 200,000 shares of NetExpress stock for $20

Per share, an arm's-length price.

DHL realized a $3.9 million

taxable gain from the 1985 sale of NetExpress stock to DHLI.

In 1982, DHL provided the initial funding for the NetExpress

tracing and tracking technology referred to as LaserNet.

amount of the funding was $290,000.

The

In 1983 and 1984, DHL made

additional equity investments in and loans to NetExpress totaling

$3,783,000.

In 1985 and 1986, DHL advanced loans to NetExpress

in the amounts of $3,107,128 and $6,000,000, respectively.

In

1986, those loans were assigned from DHL to DHLI in exchange for

an interest-bearing promissory note in the amount of $9,107,128.

The transfers of NetExpress·stock and loans to DHLI benefited DHL

by enabling it to raise cash.

When DHL Systems took over the technology functions of MRI

in 1989, it was owned 50 percent by DHL and 50 percent by DHLI.

- 65 -

.

As part of this transition, MRI's technology assets were sold to

DHL Systems.

The sale price was established by an independent

third-party appraisal and was borne by DHL and DHLI in proportion

to their ownership of DHL Systems; i.e., 50 percent by DHL and 50

percent by DHLI.

X.

Respondent's Determination

Before issuance of the notices of deficiency to petitioners,

no revenue agent's report was prepared and no international

examiners' reports were issued to petitioners.

An economist's

report was prepared in connection with the examination, but was

not provided to petitioners until a Court order compelled its

production in pretrial discovery.

The pre-notice audit process

was protracted and did not operate on a free exchange of

information basis.

Respondent issued third-party summonses

seeking information about petitioners, and petitioners would not

agree to extend the assessment peridd, triggering the issuance of

the notices of deficiency before respondent's receipt of complete

information.

The pretrial and trial dialogue in these cases was

contentious.

The parties' representatives gave no ground on any

point and protracted the trial and pretrial activity.

The trademark sale adjustments and royalty deficiency notice

determinations were developed by respondent's economist, Nicholas

Baran (Baran).

This was Baran's first IRS examination, and he

had never previously valued a trademark.

His prior experience

with discounted cash-flow analysis r^elated to bank loan

portfolios.

- 66 -

Baran determined a worldwide value for the DHL trademark of

$516,520,000 as of 1990 and $601,380,000 as of 1992.

Baran

valued the 1990 DHL trademark rights at $289,300,000 for domestic

and $227,220,000 for foreign.

Baran valued the 1992 DHL

trademark rights at $350,870,000 for domestic and $250,510,000

for foreign.

He valued the 1990 .through 2004 DHL domestic

trademark rights at $140,800,000, and valued those same rights

beginning in the year 2005 at $148,500,000, as of 1990.

Baran

valued the 1992 through 2006 DHL domestic trademark rights at

$170,370,000, and he valued those same rights beginning in the

year 2007 at $180,500,000 as of 1992.

Baran considered a royalty rate in a license agreement

between DHLI and a controlled subsidiary as a standard for use in

valuing the DHL trademark.

He used a 3-percent royalty rate for

his discounted cash-flow analyses and for his trademark royalty

determinations.

Baran relied upon a general industry survey of

the licensing practices of unidentified companies.

The trademark

royalty adjustments proposed by respondent's trial experts were

less than the adjustments for the corresponding years in the

deficiency notices.

Walter Earl Huff (Huff) was used as an expert by respondent

in connection with the determination of the imbalance fee,

transfer fee, and network fee adjustments in the deficiency

notices.

Huff's expertise is in the petroleum industry.

Respondent acknowledged' that the 1991 and 1992 deficiency notice

determinations relating to the imbalance and transfer fees are

- 67 -

.

incorrect because part of the amounts allocated to petitioners

had already been reported on the 199

and 1992 returns.

Huff recommended a 15-percent cost plus markup method that

was used in the deficiency notice adjustments.

The notices of

deficiency contained the same cost plus 15 percent markup method

for the transfer fee adjustment as they did for the imbalance fee

adjustment.

Respondent's trial expert on the transfer and

imbalance fees advocated a 4-percent cost plus markup.

In determining the imbalance and transfer fee adjustments,

Huff applied the 1987 adjustment amount, $2,019,600, to the years

1975 through 1986 and a prorated amount for 1974, even though the

shipment volumes were much higher in 1987.

Huff did not subtract

the trademark royalties, imbalance fees, and transfer fee

allocations from the network fee allocation, causing some

duplicate income allocation.

In proposing the network fee adjustment, Huff based his

conclusion on available information', and he did not think it

necessary to analyze DHL's profitabïlity on international

outbound and domestic shipments.

OPINION

I. Background

The nucleus about which the controverted issues revolve is a

transaction among the shareholders of petitioners and related

foreign DHL corporations and foreign investors.

Those investors

collectively became the majority shareholders in the related

foreign DHL entities.

That transaction involved the sale of more

- 68 -

than 50 percent of the portion of the DHL network outside the

United States.

Respondent determined that section 482 should be

employed to allocate income among petitioners and the related

foreign corporations.

Those allocations involve the sale and use

of trademark and the exchange and performance of services with

the potential for arm's-length pricing issues.

In particular,

respondent determined that, between controlled entities, the DEL

trademark was sold for less than its fair market value, that DHL,

as owner of the trademark, failed to charge royalties for DHLI's

use of same, that the controlled corporations did not charge or

charged less than an arm's-length amount for services between

them, and that part of DHLI's income was allocable to DHL.

Under section 482, the Commissioner has broad authority to

allocate income among commonly controlled corporations to prevent

the artificial shifting of net incomes of controlled taxpayers

and to place them on a parity with uncontrolled, unrelated

taxpayers.

Seagate Tech., Inc., & Consol. Subs. v. Commissioner,

102 T.C. 149, 163

(1994); Sundstrand Corp. v. Commissioner,

96

T.C. 226, 352-353 (1991); see also Bausch & Lomb, Inc. v.

Commissioner,

92 T.C. 525, 581 (1989), affd. 933 F.2d 1084

(2d

Cir. 1991); Edwards v. Commissioner, 67 T.C. 224, 230 (1976);

sec. 1.482-1(b)(1), Income Tax Regs.

The Commissioner's section 482 determination must be

sustained absent a showing that he has abused his discretion.

. Paccar,

Inc. v. Commissioner, 85 T.C. 754, 787 (1985), affd. 849

F.2d 393 (9th Cir. 1988).

Consequently, the taxpayer bears the

- 69 -

.

heavier than normal burden of proving that the Commissioner's

section 482 allocations are arbitrary, capr1clous, or

unreasonable.

Your Host, Inc. v. Commissioner, 489 F.2d 957, 960

(2d Cir. 1973), affg. 58 T.C. 10, 23

(1972); Seagate Tech.,

Inc.

& Consol. Subs. v. Commissioner, supra at 164; G.D. Searle & Co.

v. Commissioner, 88 T.C. 252, 359 (1987).

Whether the

Commissioner's discretion has been abused is a question of fact.

American Terrazzo Strip Co., Inc. v. Commissioner, 56 T.C. 961,

971 (1971).

In reviewing the reasonableness of the

Commissioner's allocation under section 482, we focus on the

reasonableness of the result, not the details of the methodology

employed.

Bausch & Lomb, Inc. v. Commissioner, supra at 582; see

also Eli Lilly & Co. v. United States, 178 Ct. Cl. 666, 372 F.2d

990,

997

(1967).

II. Were Respondent's Determinations in the Notices of

Deficiency Arbitrary, Capricious, or Unreasonable?

As explained above, taxpayers generally bear a heavier than

normal burden of proving that the Commissioner's section 482

allocations are arbitrary, capricious, or unreasonable.

Petitioners argue that their burden should be lessened once they

can show that the notices of defici ncy are arbitrary,

capr1clous, or unreasonable.

Petitioners contend that the

determinations in the notices are significantly different from

the determinations advanced by respondent's experts at trial.

Because of that and a procedural güestion, petitioners assert

that their burden in these cases should be to show, by only a

- 70 -

.

preponderance of the evidence, that the prices with any commonly

controlled entities were consistent with an arm's-length price,

citing Seagate Tech., Inc. & Consol. Subs. v. Commissioner, supra

at 164.

Respondent contends that the actions taken and

determinations made were reasonable under the circumstances.

Initially, petitioners point out that respondent did not

issue or provide petitioners with any notice or report of the

proposed adjustments before issuance of the notices of

deficiency.

Petitioners then outline four instances where they

contend that respondent's notice determinations were either

abandoned and/or ignored, and differing amounts and/or theories

were advanced by respondent through expert witnesses.

Respondent does not deny that petitioners were not provided

reports before the issuance of the notices of def.iciency.

Respondent generally explains that pre-notice reports were not

compiled and/or provided because petitioners postponed meetings,

delayed production, were unco,operative, and attempted to

"mislead" respondent with respect to the relationship between DH

and DHLI.

In that regard, the Court has observed that, throughout the

pretrial and trial portions of these cases, the parties were

contentious and intractable.

During the pretrial and trial

portions of these cases, respondent's third-party summonses

seeking information about petitioners remained in litigation in

other courts.

In the proceedings before this Court, the parties'

representatives gave no ground on any point, causing, in some

- 71 -

instances, the unnecessary protraction of the trial and parts of

the pretrial portion of these cases.

Petitioners did not agree

to extend the period for assessment, triggering issuance of the

notices of deficiency prior to respondent's receipt of complete

information.

The production of documents and responses to

interrogatories by petitioners lingered beyond the commencement

of the trial and necessitated certain procedural adjustments to

accommodate generally dilatory compliance by petitioners and the

untimely receipt of information by respondent.

This pattern of

activity likely permeated the administrative portion of these

cases, as respondent contends.

As a result, respondent's determinations were based on the

information that had been made available.

The issues in these

cases are, in substantial part, factual and concern the value or

price of an asset or service.

A vastly disproportionate amount

of the transcript and record consists of a "battle of experts".

After the notice of deficiency was s¢nt, respondent received

substantial amounts of information that had not been available to

respondent prior to the issuance of the deficiency notices.

Respondent's experts used that info mation to reach their

conclusions.

The adjustments in respondent's notices exceeded

the amounts respondent's experts op ned for purposes of trial.

The examples cited by petitioners in support of their

position include the trademark determination.

During the

administrative portion of this controversy, respondent's

economist, Baran, estimated that the worldwide value of the DHL

- 72 trademark was $516.5 million on the first of two valuation dates,

and $601.4 million on the second.

Respondent's experts, using

differing assumptions and factual information, reached

substantially reduced amounts.

Baran also developed a trademark

royalty based on a 3-percent rate relying on certain comparables.

He concluded that for the 1974 through 1992 period the arm'slength royalty should have been $232,109,000, whereas

respondent's trial experts, again using differing assumptions,

concluded that arm's-length royalties should be $83,129,000 for

1982 through 1992 or $57,095,000 for 1984 through 1992,

respectively.

With respect to imbalance and transfer fees, duplications

were contained in the notices of deficiency.

The imbalance

adjustments included the cost of deliveries that had already been

reported on petitioners' returns.

The determination, in addition

to the cost amounts, added a 15-percent markup instead of the 2percent markup reported.

Respondent's trial expert, however,

recommended a 4-percent markup, and respondent, for purposes of

trial, conceded that the determination was overstated to the

extent of the cost duplication portion of the above-described

adjustment.

Finally, with respect to the network fee, the adjustment

contained some duplication.

Respondent's trial expert on this

subject used a differing terminology to describe his proposed

adjustment, and petitioners argue that either respondent has

therefore abandoned the network fee adjustment set forth in the

- 73 .

notices of deficiency or the network fee determination must be

regarded as arbitrary, capricious, and unreasonable.

Respondent

counters that the network fee adjustment has not been abandoned

and the approach taken in the notices and by the respondent's

trial expert are reasonable.³

Petitioners seek to lessen their burden with respect to each

and every section 482 adjustment in controversy.

Petitioners'

burden is to show that each section 482 adjustment is arbitrary,

capricious, and unreasonable.

To do that, taxpayers normally

show that the questioned transactions were conducted under an

arm's-length standard.

For purposes of seeking a lesser burden,

petitioners do not address the ultimate question of what the

proper arm's-length standard is.

Instead, they argue that

respondent's notices of deficiency are generally arbitrary

because of failure to provide advance notification of the

proposed determinations and because each of the section 482

determinations differs from the amouùts, positions, and evidence

offered by respondent at trial.

In Perkin-Elmer Corp. v. Commis3ioner, T.C. Memo. 1993-414,

the Commissioner based the notice of deficiency section 482

determination on a particular theory and then abandoned that

theory before trial.

It was held that those circumstances were

sufficient for the taxpayer to meet ,"its burden of showing

respondent's allocations to be arbitrary, capricious, or

3 Due to our holding on the network fee issue, it is

unnecessary to decide the parties' contentions.

- 74 ,

unreasonable."

Therefore the taxpayer in that case needed only

to show that the questioned transactions were arm's length.

In National Semiconductor Corp. & Consol. Subs. v.

Commissioner, T.C. Memo. 1994-195, the determinations in the

notice of deficiency were based on a different methodology than

the Commissioner's expert relied on at trial.

In addition to the

differing methodology, the Commissioner's proposed reallocations,

for purposes of trial, were substantially lower than the notice

determination amounts.

Finally, at the trial in that case, the

Commissioner did not support the notice determination and,

instead, relied on the trial expert's analysis of the case.

In these cases, respondent's failure to prepare or provide

pre-notice reports is not a violation of petitioners' rights.

See Luhring v. Glotzbach, 304 F.2d 560 (4th Cir. 1962); Vallone

v. Commissioner, 88 T.C. 794, 806-807 (1987); Estate of Barrett

v. Commissioner, T.C. Memo. 1994-535, affd. 87 F.3d 1318

Cir. 1996).

(9th

Nor is respondent's failure to provide pre-notice

reports a procedural flaw that, per se, renders respondent's

notice determinations arbitrary, capricious, or unreasonable.

That is especially true here where petitioners' resistance and

dilatory approach was, to some extent, the cause of respondent's

agents' inability to provide pre-notice reports to petitioners.

For the most part, petitioners complain of the excessive

nature of respondent's notice determinations or that respondent's

trial experts' reports and testimony would support substantially

smaller income tax deficiencies.

That, in itself, does not make

- 75 - .

respondent's determinations arbitrary..

essence of the controversy here.

Those matters are the

Respondent's trial and briefing

positions do not result in an increased adjustment from those in

the notices of deficiency.

Nor has respondent advanced a new

legal theory or issue for which respondent would bear the burden

of proof.

Unlike the circumstances in Perkin-Elmer Corp. v.

Commissioner, supra, respondent has not abandoned the notice

positions and advanced new ones.4

Petitioners have not shown

that any of respondent's section 482 determinations are

042

arbitrary, capricious, or unreasonable on the basis of the

information available to respondent at the time of the issuance

of the notices of deficiency.5

We hold that respondent's failure

to provide pre-notice reports, either alone or in conjunction

with the larger amounts determined in the notices as opposed to

the trial position amounts, does not provide a predicate for the

remedial action sought by petitioners.

4 Our reference to "positions" here does not include the

"network fee adjustment".

5 Petitioners ask us to judge |respondent's actions in the

notices of deficiency. Obviously, we cannot judge whether

respondent's determinations were arbitrary, capr1clous, or

unreasonable on the basis of the information available to

respondent after the trial record has been made, unless that

information was available to respondent when the determination

was made.

In the context of petitioners' preemptive approach, we

consider respondent's actions on the basis of the knowledge that

was made available by petitioners. To do otherwise would

encourage taxpayers to keep from the Commissioner the information

they possess and then criticize the Commissioner's lack of

information to the taxpayers' advantage.

- 76 -

.

In this setting, respondent's notice determinations were not

shown to be arbitrary, capricious, or unreasonable.

Although

respondent's trial position amounts are considerably less than

the amounts determined in the notices, with the exception of the

network fee adjustment, respondent's notice positions were not

abandoned or ignored.

To some extent, the reduced adjustments

proposed by respondent at trial are attributable to information

acquired by respondent after issuance of the notices of

deficiency.

Ultimately, the factual information exchanged by the

parties and then offered into evidence forms the basis for our

opinion.

The amounts decided are considerably less than the

amounts determined in the notices.

The decided amounts, however,

fall somewhere in between the extreme trial positions of the

parties.

The large difference between the amounts contained in

respondent's notices and those proposed at trial and the

differences between the parties' trial positions are largely

attributable to the assumptions adopted by the parties' experts.

For example, respondent's in-house expert used a 15-percent

markup on the imbalance costs, whereas respondent's trial expert

used a 4-percent markup.

Ironically, because petitioners' expert

advocated a full cost approach to the imbalance adjustment, he

was able to appear magnanimous by using the same 15-percent

markup that had been used by respondent's in-house expert in the

notice.

This serves to illustrate that differences in

assumptions made large differences in the determinations and the

- 77 -

parties' positions.

The assumptions Irelied on by respondent were

not arbitrary, capricious, or unreasonable considering the

circumstances here.

Accordingly, respondent's notice determinations, although

resulting in determinations at the outside margins, represent a

reasonable protective approach based on the information that was

made available and the conditions extant at the time of the

determination.

Therefore, petitioners have not shown that they

should be relieved from showing an abuse of discretion by

respondent.'

III.

The Question of Control

Respondent's authority to allocate income is predicated on

the entities' being commonly controlled.

482,

For purposes of section

"control" is broadly defined to include "any kind of

control, direct or indirect, whether legally enforceable, and

however exercisable or exercised."

Tax Regs.

sec. 1.482-1A(a)(3), Income

In determining whether entities are commonly

controlled, the courts look to "reality of control" rather than

just to actual stock ownership.

Grenada Indus., Inc. v.

Commissioner, 17 T.C. 231 (1951), a fd. 202 F.2d 873

1953).

(5th Cir.

Further, when the interests controlling one entity and

those controlling another have a conmon interest in shifting

6 Ultimately, our ruling on this aspect has no effect on

the outcome of the issues. In one instance, petitioners showed

an abuse of discretion; in all others the outcome was based on a

preponderance of the evidence to decide fair market value or

arm's-length prices. The ultimate findings or holding generally

fell somewhere in between the parties' trial positions.

- 78 -

income from the former to the latter, entities may be considered

commonly controlled.

This is especially true where one entity

deals with another on other than an arm's-length basis.

Sec.

1.482-1A(a)(3), Income Tax Regs.

Because petitioners argue that DHL and DHLI were operated in

a separate manner, and because of the two-step progression of the

transaction with the foreign investors, the question of control

must be addressed at three different points.

First, there is the

period prior to 1990 when there was some common stock ownership

between DHL and DHLI.

Then we must consider the interim period

1990 to 1992 when the foreign investors collectively had less

than a majority of the stock holdings and had a majority of the

DHLI board seats.

And finally, there is the period after the

foreign investors exercised their "option" collectively to

acquire a shareholding majority.

Until the time of trial, petitioners denied the existence of

any common control within the meaning of section 482.

At trial,

petitioners conceded that the requisite control existed before

1990, so that the remaining controversy as to control concerns

the 1990 to 1992 period and the period after the foreign

investors gained collective shareholding control of the foreign

portion of the DHL network.

A. Was There Common Control After December 7, 1990?

Petitioners contend that the foreign investors gained

control of DHLI/MNV as of December 7, 1990, when they became able

to exercise their contractual right to appoint 7 of the 13 board

- 79 -

.

members of DHLI's and MNV's boards.

Petitioners acknowledge that

the DHL shareholders retained legal title to a majority of the

outstanding shares, but they argue that actual control should be

distinguished from legal ownership.

Even if the DHL shareholders

are found to have controlled the entities within the meaning of

section 482, petitioners argue that the transfers of the DHL

trademark did not occur until September 17, 1992, about 1 month

after the August 18, 1992, exercise by the foreign shareholders

of the option enabling them to collectively hold 57.5 percent of

the shares in the new corporate entity that replaced DHLI/MNV.

Conversely, respondent argues that the DHL shareholders

maintained the requisite control aftër December 7, 1990, because

the foreign investors collectively held only 12.5 percent of the

outstanding stock until their exerci5e of the 1992 option.

Respondent attempts to minimize the foreign investors' board

control by contending that they did not have an agreement among

them to vote their shares to elect directors.

In addition,

respondent contends that certain limitations placed on the

board's powers lessen the effect of

up the majority of that body.

he foreign investors' making

Finallly, respondent argues, in the

alternative, that section 482 would permit reallocation because

the common control factor should be beasured at the time the

parties arrange and agree to the transaction in question and not

necessarily at the time the transfe¢(s) or services occur.

We agree with respondent that the requisite control existed

after the first stage of the transaction (December 7, 1990), even

t

- 80 -

though the foreign investors collectively had been given the

ability to control the boards.

One of the underlying purposes of

the two-stage transaction was the comfort of the foreign

investors.

They had conducted a thorough due diligence and

uncovered a number of concerns.

The creation of a two-stage

transaction permitted them to become involved in the entities in

order to decide whether they wished ultimately to acquire a

larger financial commitment and shareholding, along with the

acquisition of the DHL trademark.

Initially, the foreign investors collectively purchased a

12.5-percent interest in DHLI/MNV, but they would not have been

able to recoup their investment if they had not opted

collectively to acquire an additional 45 percent of the entities

and/or the DHL trademark.

Their ability to control the boards

gave them a form of assurance or security to protect their

initial investment and to permit closer scrutiny and involvement

if they so desired.

The boards, however, did not control the

day-to-day operations of DHLI/MNV, and the foreign investors'

employee presence in the operating entities was de minimis during

the interim period (late 1990 to late summer 1992).

The structure of the transaction through the interim period

also included several assurances and protections for the DHL

shareholders.

For example, the DHL shareholders had to approve:

Any board action that changed the employment status of Lupo and

certain other employees; the issuance of DHL shares or other

related securities; certain actions concerning debt or leases;

- 81 -

,

and changes in DHL's auditors or accounting policy.

In addition,

certain key board decisions required'supermajority approval,

including:

Amendments to the bylaws'and articles of association;

entering into a new business other than one that was directly

related to the principal business of DHL; reappointment of the

CEO; certain debt or lease financing decisions; and matters that

exceeded a fair market value of $20 million, excluding the

exercise of the trademark option.

For these matters, the foreign

investors' majority was not sufficient for control.

Accordingly, the foreign investors did not have shareholding

control, and, as to many critical matters, their collective board

control was limited.

We must also weigh the fact that the

foreign investors did not have an agreement to collectively

control the board or to take any particular actions together.

Considering the above, we hold that requisite control

existed for application of section 482 during the interim (1990

to 1992) period that concluded when the foreign investors

exercised their options and acquired additional shares.

B. Effect of the Trademark Transfer After the Foreign

Investors Attained Their Collective Shareholding Maiority of the

New DHLI/MNV Entity

Petitioners argue that, even if the Court should find that

the requisite control existed during the interim period, the

trademark rights should not be subject to a section 482

allocation because the trademark rights were transferred about 1

month after the exercise of the foreign investors' 45-percent

share option.

Petitioners contend that respondent may not

- 82 .

reorder the steps of the trademark transfer portion of the

transaction and conclude that it occurred before the foreign

investors actually gained control of DHLI/MNV or its successor.

Respondent counters that the requisite control should be

measured or considered when the controlling persons or entities

are dealing with each other.

Under respondent's approach, all

that is necessary is that the control exist when the parties

irrevocably bind themselves to a transaction.

Under this

approach, accordingly, even though the parties' execution of the

agreement terms may occur when control no longer exists,

respondent would have section 482 authority to reallocate.

Respondent relies on Rooney v. United States, 305 F.2d 681, 683

(9th Cir. 1962), a case in which expenses incurred by a

liquidated corporation were allocated to a successor corporation

that had profited from transferred assets on which the expenses

were incurred.

We agree with respondent and hold that it is appropriate to

use a transactional approach to a specific transaction that was

formulated at a time of requisite control and executed after the

requisite control no longer existed.

That is especially so here,

where the options for the foreign shareholders to gain control

and the transfer of the trademark rights to the new foreign

shareholder corporation were part of the same transactions, the

terms of which were preconceived, concurrent, and interdependent

and occurred within 1 month of each other.

A transactional

approach is appropriate where the substance of the entire

- 83 -

transaction so requires.'

See Arrowsmith v. Commissioner, 344

U.S. 6 (1952), and the discussion in Cayuga Service, Inc. v.

Commissioner, T.C. Memo. 1975-4.

To permit petitioners to avoid

appropriate section 482 reallocation merely because they changed

the order of the events in a single series of transactions would

unnecessarily exalt form over substance.

IV.

Ownership and Value of the DHL Trademark

A.

Ownership

Respondent determined that DHL sold the DHL trademark to

DHLI for less than its fair market value.

Petitioners argue that

DHL did not own the worldwide rights to the trademark, but that

it did own the rights in the United States.

Because of the

obvious effect the ownership question may have on the question of

value, we address the ownership question first.

Ownership and value of the DHL trademark has been one of the

bones of contention between the parties.

Respondent's

determination placed the value of the worldwide rights in the

$500/$600 million range for the 1990-92 transaction.

A $20

million price was ultimately used by the parties to the

A transactional approach, however, may not be appropriate

where goods or services are independently contracted for after

the requisite control no longer exists. That should be the case

even if the form or substance of the transaction was dictated or

patterned after the approach used when requisite control existed.

In the context of these cases, it would not be appropriate to

approve reallocation of the cost of:arm's-length services

performed after the 1992 transaction concluded, unless the

requisite sec. 482 control existed after 1992. Because of our

holdings on the post-1992 issue, we need not address the control

question for that period.

- 84 -

transaction after $50 million had been considered and $100

million asked.

Petitioners' and respondent's pre- and post-trial

experts attempted to support all of these values and a myriad of

amounts falling in between.'

One of the underlying disputes regarding the value of the

DHL trademark rights involves whether DHL owned the worldwide or

merely the U.S. rights.

Most of the documents and evidence show

or state that DHL owned all of the rights.

DHLI's general

counsel, beginning in the mid to late 1980's, however, maintained

that DHLI owned the rights to the trademark outside the United

States.

The parties here provided expertise supporting both

positions, and we have considered each.

A trademark is a marketplace device by which consumers

identify goods and services and their source.

In the context of

trademark nomenclature, a trademark symbolizes "goodwill" or the

likelihood that consumers will make future purchases of the same

goods and services.

In a licensing arrangement, the goodwill

symbolized by the trademark is owned by the licensor, even though

created by the licensee's efforts.

v. Cotton Gin,

Inc.,

See, e.g., Cotton Ginny, Ltd

691 F. Supp. 1347 (S.D. Fla. 1988).

Trademark recognition develops from years of advertising, consistent packaging, promotional campaigns,

customer service, and quality control. Depending on

8 To some extent, it seems that the experts' willingness to

support such disparate values is one of the reasons for the

escalation and protraction of the controversy in these cases.

Indeed, the difference between $20 million and $600 million may

be sufficient spoils to incite and inspire the meekest and least

confrontational amongst us.

- 85 -

.

the strength of a trademark, the maintenance of the

desired consumer awareness level, generally requires

significant, continuing advertising investment and

product renovation. Trademarks ,lose substantial value

without ädequate investment, management, marketing,

advertising, and sales organization.

Nestle Holdings, Inc. v. Commissioner, T.C. Memo. 1995-441, revd.

and remanded on other grounds 152 F.3d 83 (2d Cir. 1998).

The validity of a trademark license is dependent upon the

licensor's control over the nature and quality of goods and

services sold under the trademark by the licensee.'

The quality

control requirement has been codified in the Lanham Act,

15 U.S.C. secs. 1055, 1127 (1994), and is judicially recognized.

See Haymaker Sports, Inc. v. Turian, 581 F.2d 257, 261 (C.C.P.A.

1978); Dawn Donut Co. v. Hart's Food Stores, Inc., 267 F.2d 358,

366-367 (2d Cir. 1959).

A purported trademark license without

quality control can result in abandonment of the licensor's

rights in the mark, a condition that has been also denominated "a

naked license".

871

Stanfield v. Osborne Indus., Inc., 52 F.3d 867,

(10th Cir. 1995); see also 2 McCarthy, McCarthy on Trademarks

and Unfair Competition, sec. 18.48, at 18-75 to 18-76

1997).

(4th ed.

The parties' experts all agree that quality control is

essential to a valid license.

Trademarks are territorial, and different ownership of the

same trademark is possible in different countries.¹°

In the

See 2 McCarthy, McCarthy on.Trademarks and Unfair

Competition, sec. 18:42, at 18-66 (4th ed. 1997).

1°

4 McCarthy, supra sec. 29:7,

- 86 -

,

United States, trademarks may be created by use and protected by

registration.

Outside the United States, trademark rights may be

created by use and/or registration, and, in some instances,

registration is prima facie evidence of ownership.

First, we briefly review the factual background for the

development and use of the trademark within the DHL worldwide

network.

The DHL worldwide network began with a single company

and, because of a competitor's complaints to the CAB, was divided

into essentially two operating entities--domestic (within the

United States) and international (outside the United States).

Although the shareholdings of the domestic and international

business entities appeared disparate, in actuality the entire

network was controlled by a group of shareholders, who ultimately

split up profits from the sale of a part of the network in accord

with their preconceived understanding that did not necessarily

comport with the ostensible shareholdings.

The domestic and international operating entities were

relatively autonomous in their day-to-day operations but were

overseen and controlled by various groups and/or entities

controlled by the common controlling shareholders.

All of the

agreements, written or understood, reflect that DHL owned the DHL

name (trademark) and that DHLI was allowed to use it because of

DHL's consent.

DHLI, however, caused registrations of the DHL

trademark in numerous countries in which the DHL network provided

services.

Those registrations were in the name of DHLI and/or

its related international entities and did not reflect that DHL

- 87 -

,

owned or licensed the trademark.

In addition, DHLI's general

counsel contended, in spite of written agreements to the

contrary, that DHLI owned the trademark rights outside the United

States because of DHLI's foreign registration of the trademark.

With this somewhat generalized background, we consider the

positions of the parties and their experts on the question of

ownership of the DHL trademark.

Petitioners contend that DHL

owned the rights inside and DHLI ownhd them outside the United

States.

Respondent contends that DHL owned the worldwide rights

before the transaction with the foreign investors.

Respondent makes a three-point argument in support of the

position that DHL owned the worldwide rights in the trademark.

First, respondent argues that, as a

atter of trademark law, DHLI

was contractually cast as a licensee and that the requisite

control existed as between the licensor and licensee to maintain

and perfect DHL's trademark ownership.

Second, respondent argues

that petitioners may not disavow the form they chose and that the

1974 MOA, subsequent amendments, and other documentation placed

ownership in DHL.

Finally, if we find that the requisites for

trademark ownership were not extant

respondent argues that the

contracts entered into by DHL and DHLI were still enforceable, as

between them.

Petitioners take a different tack from respondent's approach

by arguing that the arrangement between DHL and DHLI would not

meet the applicable section 482 regulations so as to require

reallocation as to that intangible asset.

Petitioners also argue

- 88 -

.

that, as a matter of law, trademark rights exist separately in

each country of registration and DHLI acquired the rights by

registration and use.

If we decide that DHL owned the worldwide

rights to the trademark, petitioners argue that they should be

allowed a setoff equal to the value of assistance or cost borne

by DHLI in developing the trademark rights outside the United

States.

The parties provided four well-qualified experts on

trademark law.

Respondent's expert on trademark ownership is a practicing

lawyer with 30 years' experience, including litigation, in

intellectual property law, specializing in trademarks and unfair

competition.

He concluded that, with the possible exception of

certain Central American countries, the agreements between DHL

and DHLI established DHL as the owner of the trademark rights.

His interpretation of the 1974 MOA and related agreements is that

they give DHL the ownership in the trade name and trademark, in

particular because DHLI could not assign the foreign

registrations without DHL's consent and because of DHLI's

obligation to cease use everywhere for 5 years upon termination

of the DHL/DHLI relationship.

He also opined that DHLI was a

licensee of the trademark, and nothing in the trademark law

served to change that relationship between DHL and DHLI.

Respondent's expert's conclusions are based, in part, on DHL

and DHLI's agreement that New York law would govern the trademark

issue beginning in 1990 and that the 1974 MOA contained an

- 89 -

arbitration clause under the laws existing in the U.S. District

Court in the Territory of Guam.

Petitioners offered three experts on the question of

trademark ownership, two professors, each with 30 years'

experience in this field, and a British solicitor who specializes

in trademarks in the United Kingdom and other countries.

Both

professors, when measuring the writtén agreements between DHL and

DHLI against the exacting standards of trademark law, concluded

that DHL owned the trademark rights within the United States and

DHLI owned the rights outside the United States.

The solicitor

concluded, by means of a six-1ssue aüalysis, that the trademark

was not "an indivisible global assetiowned by DHL" and that a

decision of a court of the United States would not affect DHLI's

rights in the existing registrations in foreign countries.

The reports and testimony of the experts provided the Court

with helpful guidance in this technical and specialized area of

the law.

To some extent, we agree with each of the parties'

experts.

Petitioners' experts defined the strict letter of the

law to perfect and maintain trademarks in the United States and

abroad.

Respondent's expert, as a trial lawyer, advanced a more

practical formulation, reflecting w at would have resulted if the

parties' agreements and actions were contested and subjected to

litigation.

The informality and lack of precise language used by DHL and

DHLI would have caused more problems in transactions between

unrelated third parties seeking to enforce their rights to the

- 90 -

DHL trademark.

But here we have corporate entities with

interlocking shareholder control and a common purpose of

establishing and maintaining a worldwide delivery network under

the name "DHL".

DHL's and DHLI's respective rights and

obligations concerning the trademark are sufficiently defined to

be enforceable.

Both parties agree that DHL's ownership of the

trademark in the United States is without question.

DHL's lack of involvement in the foreign registrations and

the lack of precise and more formal agreements and standards,

however, lessens the quality of DHL's ownership rights and

interests in the registration and rights to the DHL trademark

outside the United States.

Because DHL had the ability to

terminate and/or cause DHLI's inability to use the trademark for

a 5-year period, the import of DHLI's foreign registrations is

mitigated.

Finally, in the factual context of these cases,

common shareholders controlled DHL and DHLI, and the foreign

investors had the option to acquire a collective majority

interest in DHLI/MNV and the DHL trademark worldwide.

Although

that fact should not have an effect on the stand-alone value of

the trademark, in the enforcement of ownership context, it has

the effect of neutralizing the foreign registrations in DHLI's

name.

These weaknesses in the quality of DHL's ownership of the

DHL trademark do not have the effect of making DHLI the

uncontested owner of the trademark rights outside the United

States, but would have a profound effect on a buyer's willingness

to pay top dollar and the value of the DHL trademark worldwide.

- 91 -

We hold that DHL owned and contrölled the worldwide rights

to the DHL trademark, but that, as discussed above, the rights

outside the United States were subject to weaknesses and

questions that would affect the quality and value of DHL's

interest.

Our conclusion and holding;is also based on the

following analysis.

After dividing the DHL network into domestic and foreign

operating entities, DHL and DHLI entered into the 1974 MOA which,

in part, concerned the DHL trademark.

The parties used the term

license" to describe DHL's agreement to allow DHLI to use the

name "DHL".

Throughout subsequent amendments of the 1974 MOA,

that terminology was not contradicted or expressly modified.

For

most of the period under consideration, DHL had the ability to

terminate the arrangement, which would have contractually

prohibited DHLI from using the trademark for a period of 5 years.

In negotiating with investors interested in part or all of the

DHL network, DHL was represented as the owner of the DHL

trademark worldwide.

Although there was some doubt about the

quality of DHL's ownership of the international rights to the

trademark, the parties to the transaction in question treated DHL

as the worldwide owner.

Only DHLI'sigeneral counsel held the

view and expressed doubt about DHL'siownership of the rights to

the trademark outside the United States.

There can be no doubt

here, however, that the shareholders and principals of DHL and

DHLI/MNV intended that DHL own the trademark and that DHLI's

interest was that of a licensee.

- 92 ,

Petitioners attack the license terminology that they used to

cast the relationship between DHL and DHLI as to the trademark

and its use by arguing that the mere expression of the term

"license" does not establish and/or maintain a license

relationship.

They argue that, without quality control exercised

by the trademark owner (licensor) over the licensee, ·the

requisite control of the trademark use and services performed by

the licensee would not exist.

However, respondent has shown by ample evidence in the

record that, as between DHL and DHLI, the requisite control did

exist.

The existence of that control is found in the unique

relationship of the corporate entities, their shareholders, and

the manner in which the business entities were operated,

coordinated, and presented to the public as a worldwide delivery

network with the name "DHL".

Although the 1974 MOA and other

documents that defined the ownership, rights, and use of the

trademark fall short of the strictest quality control standards

requisite for a textbook-quality license agreement that may be

required as between unrelated third parties, they are sufficient

and enforceable in the circumstances here.

Petitioners make a collateral attack on the ownership issue.

They seek refuge in section 482 regulations in an attempt to show

that the form they chose should not be respected.

Petitioners'

argument focuses on the 1968 regulationsll and points out that

"

The parties refer to the regulations that were

(continued...)

- 93 -

they do not contain mention of a license as a factor relevant to

which person or entity should be considered to have "developer"

status of intangible property.

Income Tax Regs.

See sec. 1.482-2(d)(1)(ii),

In essence, petitioners argue that legal

ownership should be disregarded for purposes of any section 482

reallocation of intangibles.

Respondent argues that the facts here support a finding that

DHL is the developer or that the regulations in question provide

that, in the absence of a bona fide cost-sharing arrangement,

042

respondent may make allocations upon the transfer of intangible

property by the developer to a related entity.

Respondent

further contends that there was no cost-sharing arrangement

between DHL and DHLI.

Finally, respondent contends that

petitioners failed to show that DHLI either developed or assisted

in developing the.intangible (trademàrk) because it has not been

shown that the advertising expenditures incurred by DHLI were

more than what would have been incurred at arm's length; i.e.,

allocation from DHL to DHLI is not appropriate.

Petitioners counter that respondent may not choose either to

"invoke" the section 482 regulations and make an allocation based

"(...continued)

promulgated in 1968 because the newer sec. 482 intangible

property regulations were adopted in 1994, and petitioners did

not elect, pursuant to sec. 1.482-1(j), Income Tax Regs. (1994),

to have them apply retroactively.

Sec. 1.482-2(d), Income Tax Regs., was effectively

superseded by sec. 1.482-4T, Temporary Income Tax Regs., 58 Fed.

Reg. 5263, 5287 (Jan. 21, 1993), generally effective for taxable

years beginning after Apr. 21, 1993.!

1990,

1991, and 1992.

The tax years in issue are

- 94 -

on the developer/assister standard, or to ignore those

regulations and make an allocation "pursuant to" the parties'

licensor/licensee relationship.

Petitioners rely on the language

of section 1.482-2(d)(1)(ii)(a), Income Tax Regs., that "no

allocation * * * shall be made" with respect to a transfer of

intangible property unless either (1) there is a "bona fide cost

sharing arrangement" as defined in section 1.482-2(d)(4), Income

Tax Regs., or (2) the intangible has been transferred by the

"developer" within the meaning of section 1.482-2(d)(1)(ii)(c),

Income Tax Regs.

Petitioners contend that respondent has denied

the existence of a bona fide cost-sharing arrangement in these

cases and that, therefore, any section 482 allocation must be

based on the developer/assister standard.

Finally, petitioners

contend that respondent, under the regulations, may make an

allocation (reduction of value) for an "assistance" provided by

DHLI if DHLI is not considered the "developer" of the intangible.

The referenced regulations are clearly not intended for the

purpose of deciding the ownership of an intangible.

they are designed to assist in allocation.

Instead,

In that regard,

petitioners argue that the referenced regulations ignore

ownership in the process of allocating an arm's-length price.

In

answering the question of whether the ownership of the DHL

trademark was bifurcated between DHL and DHLI, we do not look to

the section 482 regulations cited by petitioners.

Although those

regulations may have some effect on our allocation decision, they

- 95 -

are not relevant in deciding the ownership of the trademark

rights as a predicate for valuing th

trademark.

Petitioners contend that they sold only the U.S. trademark

rights.

Because we have decided the ownership question, we will

consider whether and to what extent the section 482 regulations

may have an effect on allocation of the value.

B.

Value of the DHL Trademark

As previously noted, the value of the worldwide right to the

DHL trademark as determined by respondent in the deficiency

notices is almost $600 million greater than the value advocated

by petitioners.

In that regard, we note that such extreme

differences "demonstrate the caution that 1s necessary in

weighing expert valuations that zealbusly attempt 'to infuse a

talismanic precision into an issue which should frankly be

recognized as inherently imprecise' '(Messing v. Commissioner, 48

T.C. 502,

512

(1967))".

312, 338

(1989).

Estate of Hall v. Commissioner, 92 T.C.

On brief, petitioners argue that the $20 million price

agreed to by the parties to the transaction was at arm's length

because of the differing and adverse interests as between the

controlling shareholders and the foreign investors.

Petitioners

also contend that the 1989 negotiations established "a $50

million ceiling value" for the DHL trademark worldwide.

The main

thrust of petitioners' argument on value is that tangible and

intangible components (other than the trademark) of the DHL air

express network and the ability to efficiently deliver are worth

- 96 -

more to customers than the DHL name, and, therefore, the network

was "far more valuable" than the trademark.

Respondent, on the other hand, contends that an analysis of

the values used by the parties to the transaction will reflect

that the intangibles, primarily the trademark, were valued by the

foreign investors at almost $300 million12 and that amount

comports with respondent's experts' proffered values.

As an

alternative, respondent argues that value resides in DHL's

retention of the right to use the DHL trademark in the United

States for a period of years as additional noncash consideration

citing Alstores Realty Corp. v. Commissioner, 46 T.C. 363

(1966).

Respondent's notice determination was based on alternative

valuation dates in 1990 and 1992.

The use of two possible dates

is likely due to confusion over when the DHL trademark should be

valued.

The confusion probably arose because the transaction and

Prices to be paid were agreed to during 1990 and the actual sale

or exchange occurred in 1992.

We have no question about the fact

that the taxable event occurred in 1992, and any additional

capital gain from petitioner's sale of its interest in the DHL

trademark would be includable in the 1992 taxable year.23

On

¹² Respondent's determination alternatively valued the

trademark in 1990 and 1992. The 1992 valuation produced the

higher amount approximating $600 million and the 1990 valuation

was closer to $500 million. Respondent's litigating position,

which is based on the 1990 date, approximates a $300 million

value for the trademark.

13 On brief, both parties advocated 1992 as the year of any

recognition of income from the trademark sale.

- 97 -

brief, respondent advances only the 1990 valuations of his

experts, and petitioners do not argue that 1992 would be the more

appropriate year for valuation.

Petitioners, on brief, argue

that any capital gains adjustment attributable to the sale of the

trademark should be recognized in 1992.

It therefore appears

undisputed that any such adjustment should be recognized in 1992,

but valued as of the time the right to acquire was created (1990)

for purposes of section 482."

Trademarks, trade names, brand names, and other similar

items are treated as intangible property and are covered by

section 1.482-2(d),Income Tax Regs.

(1968), which deals with the

transfer or use of intangible property.

Section 1.482-

2(d)(2)(ii), Income Tax Regs., provides the general rule that, in

determining "the amount of an arm's length consideration, the

standard to be applied is the amount that would have been paid by

an unrelated party for the same intangible property under the

same circumstances."

The regulation'goes on to enumerate the

following factors that may be considered in arriving at the

amount of the arm's-length consideration:

(a) The prevailing rates in the same industry or

for similar property,

(b) The offers of competing transferors or the bids of

competing transferees,

" Petitioners also argued that, the sale of the trademark

occurred after the foreign investors gained collective control of

the international entity so that sec. 482 should not apply for

lack of the requisite control. We have already addressed that

question and resolved it adversely to petitioners.

- 98 -

(c) The terms of the transfer, including limitations on

the geographic area covered and the exclusive or

nonexclusive character of any rights granted,

(d) The uniqueness of the property and the period for

which it is likely to remain unique,

(e) The degree and duration of protection afforded to

the property under the laws of the relevant countries,

(f) Value of services rendered by the transferor to the

transferee in connection with the transfer within the

meaning of paragraph (b)(8) of this section,

(g) Prospective profits to be realized or costs to be

saved by the transferee through its use or subsequent

transfer of the property,

(h) The capital investment and starting up expenses

required of the transferee,

*

*

*

*

*

*

*

(i) The availability of substitutes for the property

transferred,

(k) The arm's length rates and prices paid by unrelated

parties where the property is resold or sublicensed to such

parties,

(1) The costs incurred by the transferor in developing

the property, and

(m) Any other fact or circumstance which unrelated

parties would have been likely to consider in determining

the amount of an arm's length consideration for the

property.

Sec. 1.482-2(d)(2)(iii), Income Tax Regs.

"'[F]air market value is the price at which the property

would change hands between a willing buyer and a willing seller,

neither being under any compulsion to buy or to sell and both

having reasonable knowledge of relevant facts.'"

States v. Cartwright, 411 U.S. 546, 551 (1973)

20.2031-1(b), Estate Tax Regs.).

United

(quoting section

In addition to proving that .the

- 99 -

,

deficiencies set forth in the notices of deficiency are

.

arbitrary, capricious, or unreasonable, the taxpayer has the

burden of proving satisfaction of the arm's-length standard.

See

Sundstrand Corp. v. Commissioner, 96 T.C. at 354.

Two expert witnesses with backgrounds in business, finance,

or economics testified in support of respondent's trademark

valuation position.

Both experts used an income methodology to

value the trademark or the rights to luse (royalties).

One used

042

the relief-from-royalty approach and the other used the relieffrom-royalty approach coupled with another income methodology to

arrive at opinions of value.

One of respondent's expert's

reports reflects worldwide values for the DHL trademark of $287

million and $409 million as of the 1990 and 1992 valuation dates,

respectively.¹³

He also opined that DHL's right to use the

trademark for 15 years beginning 1992 had a 1992 value of $58

million and that DHLI's use of the trademark for 1982 through

1992 had a value of $83,129,000.

Respondent's other expert opinei that the DHL trademark had

worldwide values of $327.5 million and $489.6 million as of the

" This expert offered by respondent ascribed separate

trademark values to the U.S. and non-U.S. rights as follows:

U.S.

Non-U.S.

Worldwide

1990

1992

$93 million

194 million

287 million

$102 million

307 million

409 million

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1990 and 1992 valuation dates, respectively.2'

He also opined

that DHLI's use of the DHL trademark for 1984 through 1992 had a

value of $57.095 million, and DHL's 15-year use of the trademark,

beginning in 1992, had a $46.4 million value as of 1992.

He

calculated DHLI's revenues attributable to DHLI's use of the DHL

trademark, as follows:

1984

1985

1986

1987

1988

1989

1990

1991

1992

$367,841,000

431,929,000

534,283,000

687,427,000

832,879,000

974,050,000

1,146,312,000

1,404.800,000

1,725,850,000

The expert's computations imply that the income earned is from

the trademark and not from other intangibles or assets.

We do

not agree that these income figures show only the value of the

trademark, but they do reflect that DHLI's revenues were

generally increasing and substantial.. There is no question that

the DHL name had some role in DHL's, DHLI's, and the DHL

network's success.

Petitioners proffered one valuation expert, an economist,

who used the relief-from-royalty income approach to value the

trademark and two additional economists who opined on whether

Respondent's other expert assigned separate trademark

values to the U.S. and non-U.S. rights as follows:

1990

1992

U.S.

$89.3 million

$122.2 million

Non-U.S.

238.2 million

367.4 million

Worldwide

327.5 million

489.6 million

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valuable intangibles existed in the context of the DHL network.

One of petitioners' experts concludedl that DHLI had valuable

intangible assets including a cost advantage from its volume and

its reputation for reliable performance and that it was those

attributes and not the DHL name that had value to DHLI.

Another

of petitioners' experts, using a different methodology, similarly

opined that it was the DHLI infrastructure that made the

difference and that DHL did not possess an intangible (including

the trademark) that caused DHLI's success.

Finally, petitioners'

042

valuation expert opined that the DHL trademark had $55.2 million

and $70.2 million worldwide values on the 1990 and 1992 valuation

dates, respectively.¹7

Respondent attempts to corroborate the experts' 1990

valuations of $287 million and $327.5 million by contending that

the 1990/1992 transactional figures would support a $300 million

value for the intangibles (in respondent's view attributable to

the trademark).

Respondent points out that DHLI/MNV's combined

shareholder equity at the end of 1998 netted out at $202 million

(positive $226 for DHLI and negative $24 for MNV).

Considering

that the foreign investors paid $287.5 million for a 57.5-percent

shareholding interest of DHLI/MNV ($300 million times 57.5

Petitioners' valuation expert estimated separate

trademark values of the U.S. and non-U.S. rights as follows:

1990

1992

U.S.

Non-U.S.

$24.2 million

31.0 million

$18.2 million

52.0 million

Worldwide

55.2 million

1

70.2 million

- 102 -

percent), it follows that they were also."acquiring" 57.5 percent

of the net shareholder equity or $116.15 million ($202 million

times 57.5 percent).

Therefore,' respondent contends, the foreign

investors paid $171.35 million ($287.5 million less $116.15

million) for the "off-balance sheet assets".

Finally, if the

57.5 percent of the intangibles equaled $171.35 million, then 100

percent equaled approximately $300 million ($171.35 divided by

57.5 percent equals $298 million).

Respondent also argues that the $500 million value of

DHLI/MNV implied by the foreign investors' 57.5 percent/$287.5

million price is short of the actual value because it does not

include a control premium.

Respondent points out that although

the three foreign investors acquired a 57.5-percent interest in

concert, none of them held a majority interest, and the DHL

shareholders, either individually or collectively, did not hold a

majority interest.

Accordingly, if control had been purchased

the price would have been higher, thereby supporting an amount in

excess of $300 million for the intangibles.

Petitioners argue, and we agree, that respondent's control

premium position has no place in determining the value of the

assets individually.

More particularly, a control premium has

been held to reflect the value of the shareholder's right to

determine corporate policy, "over and above the value that is

attributable to the corporation's underlying assets using

traditional valuation methodologies."

Commissioner, 96 T.C. 606, 628 (1991).

Philip Morris Inc. v.

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As to respondent's position that the transactional figures

could support a $300 million value for the intangibles,

petitioners' rebuttal is that the transaction was arms length.

In other words, petitioners contend that the foreign investors,

on the basis of advice and information from their advisers,

independently came up with a $450 million price for the stock and

a $50 million price for the trademark.

Respondent disagrees and

contends that neither the $50 million nor the $20 million was

042

arrived at either at arm's length or on a fair market value

basis.

Respondent, in support of that position, makes

This text is long and has been trimmed here. Open the source document for the complete record.