Petition for Writ of Certiorari — Oil Base, Inc. v. Commissioner

Supreme Court brief1966

Ask Donna

What actually matters in this document.

Text

_ IN THE

a Ae _ +] Offiee-Supseme Court, U.S.

<¥, 1% a F [LED

AUG 22 "1966 °.

| Supreme Court of the he Unt

October Ternt, 1965 4 f

No. . 6 : ey 5

Om Bass, inc, ., ‘/. : rhea St.

: Petitioner,

US. A

CoMMISSIONER OF INTERNAL REVENUE,

aor ae Respondent.

| Petition for a Writ of Certiorari to the United States

Court of ichian for the Ninth \Circuit.

WI son B. CopEs,

WELLMAN P. THAYER,

900 Wilshire Boulevard,

Los Angeles, Calif. 90017,

Attorneys for Petitioner.

Parker & Son, Inc., Law Printers, Los Angeles. Phone MA. 6-9171.

\ Pd ;

ae Pe |

. ence INDEX * |

Page 3 e

The decision, ssi abd « opinions below eee

"Jurisdiction lnaveonarentosmibseetsieneontamamanheenbealenlgisncansenicitsends 2

Questions presented cnallialde oreacades SiDbvaneaene, ain a

er SN 8.

BE rmeareetentonmer arate seas acacia ce

- Reasons for granting the writ wactnneneneneinneneatan 11

Conclusion wvscnenepesSrcones meiichsicaty Rae haciie 22

‘

| INDEX: TO’ APPENDICES .

.ideppendis I. Judgment slant ; ; cen 1

” Appendix II. Opinion of the United: States Court

of Appeals for the Ninth Circuit - ae 2.

Appendix III. Memorandum n Findings of Fact and.

QPTIOIE - secsssinceseicetroceseiotns ee nseorecsncenonedecns CF

| : Cases | Page .

ae Frank 1 v. International Canadian Corp.; % 308 F. "2d.

*: ETD shaiana , gonlitcaninsslip AB, 16, 17, 19; 20

: Guat Industries, Inc., 17 T.C. 231, aff'd 202 F.

-, 2d 873, cert. den. 346 U.S. 819 ....... Ae, CRE OR

| Motors Securities Co., Inc., 11 T.C.M. 1, 17

Palm Beach Aero Corp. 17°T.C. 1169. eaten. 17 |

_ Polak’s Frutal Works, Inc;, 21 T.C. 953 :n-cnnncc 17

Seminole Flavor Co., 4 T:C..1215- aa Sel 17

Smith-Bridgman & C0.,16 T.C. 287 -cicccwnesvineie 12 ,

: Teénnessee-Arkansas Gravel Co., 112 .F. 2d 508... Cae ye

_ The Friedlander Corp., 25 T.C. FO siasesicninrteeesitgend 16 ©

: Miscellaneous 3 :

| House of Representatives Report No. 2, 70th Con-

gress, First Session (1927), p. 16 pidcilaaeenbthonins 13

House ‘of Representatives Report No. 1447, 87th Taek Sy

Congress, Second Session (1962), p. 28 ...............- 18.

Internal Revenue Bulletin ( oud 22, 1966), ° Rev-.. ;

nue Ruling 2 ee e-em 12.

Income Tax Regulations, Sec. 1 A82-1 (b)(1) AS oe 14

Internal Revenue Bulletin, Revenue Ruling 65-17, |

1965-1 Cumulative Bulletin, p. RS

Senate Report . No. 960, 70th Congress, First Ses.

sion (1928), | Eee co a

Technical Information . Releases, No. 836 sellin: a

Technical Information Releases, No. 837° .........2.....- 12

_ TABLE OF AUTHORITIES CITED

ate

| eat 2 Statutes " se , Page

- Internal Revenue Code of 1939, Sec. 45°. TOS BS, 15’

‘Internal Revenue Code of 1939; Sec. 109 oaaseeeeee ae:

Internal Revenue , Code a 1954, Sec:482 so...

siete panacea ‘inact 2; 10, 12, 13; 17, 19, 20

. Reveme Act of 1943, Sec. 128(b) | ele sical Riess 13

United: States Code, Title 26, Sec, 482 ooceeececescceeeen 2

United States Code, Title ye AY. 4, 10

he United States Code, Title: 26,°Sec. PE So 10

United States Code, Title 28, Sec. 1254(1) cc... : ae

se Textbooks | |

: New York University Twenty Fourth pame In-

stitute on Federal Taxation, p. 1433 guenpenesentfeniocnde’ 11

23 Tax Court Memorandum, p. 1838 ..........-....--- ae

erie aise capi tac Neste ahah RDS

Bainter sw

on, BASE, INC.,

IN THE.

_ Supreme Court of the United Sates

. + * .QOctober Term, 1965

PU. scbbseneinion )

_ &

Petitioner,

US. . )

"Commission OF INTERNAL REVENUE,

| " Respondent.”

~ Petition for al Writ of Certiorari to the United States

Court of Appeals for the Ninth Circuit.

Petitioner prays that a writ of certiorari issue to re-

view a judgment. of the United States Court of Ap

~ peals for the Ninth ‘Circuit entéred on May 23, 1966.

. This judgment affirmed a decision of the Tax. Court =~

of the United States which had in part sustained a

determination by the.Commissioner of Internal Reve- |

nue, the respondent herein, that there was a deficiency’

in the petitioner’s federal income. tax. liability- for its

- fiscal year ended September 30, 1959.

The Decision, Judgment and: Opinions Below.

The decision “of the Tax Court involved in this pro- :

ceeding was entered on January 12, 1965, and the Mem-

itis orandum of Findings of Fact and Opinion, filed No-

_ vember 17, 1964, while not officially reported, may .be’

found at 23 7 TCM 1838. The judgment and Opinion of

. the Court of Appeals was entered May 23, 1966, and -

a a is reported at .... F.2d...

| Jurisdiction. _

‘The judgment of the Court of Appeals for the N inth :

Circuit is dated and was entered on May 23, 1966.

- No Petition for a Rehearing was filed. The jurisdic-

tion of this Court is invoked, under 28 U. S. C. §1254-

(). » |

Questions Presented.

1. .In reallocating items of income, deduction, etc.,

under section 482 of the Internal Revenue Code of

"1954, is the Standard to be applied i in every case that of

-an uncontrolled taxpayer dealing at arm’s length with

another uncontrolled taxpayer ?

2; May the Commissioner” of the Internal Reve-

nue exercise the power conferred upon him by section -

482 of the Internal Revenue Code of 1954 in such a

manner as to create a loss in one of the controlled tax-

payers? y

| Statute Involved. |

The governing: statute involved in this. proceeding is

section 482 of the Internal Revenue Code of 1954, 26

U.S.C. §482, which reads as follows: ®.

“SEC. 482. ALLOCATION OF INCOME AND

DEDUCTIONS AMONG TAX-—

PAYERS.

In any case of two-or more organizations, trades, ° -

or businessés (whether or not incorporated, wheth- - -

er or not organized in the United States, and

whether or not affiliated) owned or controlled di-

rectly or indirectly by the same interests, the Secre-

tary or his delegate may distribute, apportion, or

——

allocate gross income, deductions, credits, or allow-

2 ances between or among such organizations, trades,

or businesses,. if he determines that such distribu-

tion, apf ‘tionment, or allocation is necessary in

order to revent.evasion of taxes or clearly to re-

flect t income of any. of such organizations,

strades, ‘or businesses.” .

Statement.

" The petitioner is a California corporation with its |

principal place of business at 3625 Southwest Freeway, .

Houston 27; Texas. During the taxable year involved —

in this proceeding the petitioner’s principal place of busi-’

ness,was at 130 Oris Street, Compton, California, and

its ficomie tax return for the fiscal year ended _ep-

tember 30, 1959, which is the only year involved in

this proceeding, was filed with the District Director

‘of Internal Revenue at Los Angeles, California:

Since approximately 1941 the petitioner and its gred-

ecessor companies have been engaged in the business

of manufacturing and selling oil base drilling fluid

and related products to the oil drilling industries. Its. -

_ principal product is an oil base drilling fluid, known as |

“Black Magic”. This is a specialized product 1 in the oil

drilling industry possessing qualities and characteristics

not found in conventional water base drilling fluids

which produce desirable results in oil well drilling and

| particularly i in certain specialized oil well drilling situa-

tions.

Despite the desirable results. achieved by the use of

petitioner’s product, it’ is’ difficult to sell because it is

expensive, dirty, and disagreeable to work with, and

thetefore the petitioner’s steal effort is directed at

; ©

ccm

wn ‘ Z ’ 6

stile,

| all levels of oil well ‘drilling personnel ranging from

the top production executives down to the drilling crews.

Since approximately 1946 the petitioner has been

selling its products abroad: in certain foreign countries

where oil drilling activity was being condycted. Prior

to October 1, 1955, petitioner’s foreign sales had been

accomplished through various independent sales repre-

sentatives.

On or about October 1, 1955, petitioner and Baritina

de Venezuela, St A., a Veneztelan corporation of Car-

. acas, Venezuela, which corporation was unrelated to pe-

titioner, executed an agreement, pursuant to which Bar-

_ itina was to act the extlusive sales representative for

petitioner’s products in the country of Venezuela. On

.or about December 1, 1955, petitioner and Baritina ex-

ecuted a document entitled “Supplemental Agreement,”

pursuant to which the country of Colombia was added

to the territory for which. Baritina was to be the ex-

clusive representative of petitioner’s products, and fur-

ther that A Z Export, S.A., a corporation, was named

as the exclusive sub-agent and distributor of petitioner’s

products in the Republic of Colombia. .

The agreement between petitioner and Baritina pro-

vided a schedule of commissions to be paid and dis-’

counts to be allowed by the petitioner to Baritina with

respect to the sale of the various products of the pe- ~

titioner. The rates of commission and discount varied

* with respect to the several products involved, but gener-

ally speaking ranged from fifteen per cent (15%) | to

twenty-five per cent. (25%).

The sales representatiom agreement between petition-

er and Baritina terminated on September 30,. 1957.

. ——

odin

° 4

After stich, termination the petitioner and Baritina

negotiated for the renewal and modification Of. the

sales representation: agreement. This negotiation consist-

ed of correspondence betWeen petitioner’s management

and Baritina’s. management, and ‘one personal confer-

ence between executives of the petitioner and a’ rep-

resentative of Baritina. The negotiation also took place

in the. light of the fact tat National Lead Company,

which among other things operated a so-called Baroid

‘division, which was a direct ‘competitor of petitioner,

had acquired forty per cent (40%) of the stock otvner-

ship of Baritina. In the negotiation Baritina demanded

an increase in the rates of commission and discount,

and further represented to the ‘petitioner that it had

just about been breaking even with Tespect to its rep- .

resentation of the petitioner.

‘These negotiations resulted’ in wiint petitioner’ s man-

agement believed to be an agreertient with respect to

a new contract, and the petitioner had its attorney

prepare a proposed contract’ embodying the terms of

the new agreement. Shortly thereafter, however, cer-

tain further correspondence, took place between peti-

tioner and Baritina in which Baritina stated that it

could not agrée. with certain of the provisions of the

proposed contract” The petitioner would not agree to

the elimination of these provisions, and thereafter in

April. of 1958 negotiations between ‘the petitioner and

Baritina were completely terminated. —

After these_ negotiations were terminated, the ne

titioner’s management for some time considered the.

question of, how it was going to continue to market its .

prodiicts in foreign countries. After consulting both

their regular corporate. counsel in Los »Angeles,’ Cali- .

other of the petitioner’s products. ~

~~» fornia, and a Venezuelan attorney, the petitioner’s Board

of Directors decided to form a wholly owned Venezuela

corporation which, would act as the. petitioner’s sales

representatives in foreign countries. Accordingly, on or

~ about June 13,1958, petitioner caused the formation of

Oil Base’de Venezuela, C.A., a Venezuelan corporation,

as a wholly owned subsidiary of the petitioner.

Thereafter, on or about June 20, 1958, petitioner and

Oil Base de Venezuela executed an agreement: pursuant

to which Oil. Base de Venezuela was to act as the pe-

_ titioner’s exclusive sales representative for the sale of

petitioner’s products in all countries of the world, ex-

cluding therefrom all of the ‘states of the United States

of ‘America and all of the Provinces sy te the Dominion

of Canada. , ys ;

This sales representation agreement between petition-

er and Oil Base. de’ Venezuela’ provided for rates of

‘commission and discount’ in essence as follows: Twen-.

ty per cent (20%) of the net invoice billings of sales, ’

exclusive of transportation, packaging, insurance and

taxes of those products of petitioner: known as O. B.

Wate, Filter Presses, Additive “V”, O. B. Zero, Mixfix,

Additive “X”’, and Additive “E”, and forty eh P

(40% ). of the net invoice billings of sales exclusive’ of

transportation, insurance, packaging, dnd taxes of all

‘-

- Such exclusive representation agreement between pe-

titioner and Oil Base de Venezuela ‘was for a period

commencing June 20, 1958, and ending January $1,

1959, but such agreement was extended for an addi-

‘tional year to and including the 3lst day of December,

1959, and was further eventually extended to include

the calendar years 1960, 1961, and 1962.

. \ ;

In establishing the rates of commission and discount. . ,

which would be paid or allowed to Oil Base de Vene-

zuela as its exclusive sales representative, the petitioner,

through its Board of Directors, considered the follow-

ing factors:

‘1. . That Baritina had represented to wetltiinad that

it had just about been breaking even on its representa- a ;

tion of the petitioner,

2. That Oil Base de Venezuela would be selling’ ailie

ly the products of the petitioner, whereas Baritina rep-

resented the products of several manufacturers, and;

consequently, had a broader base over which to spread ©

its overhead costs,

3. That-Oil Base de Venezuela would be a starting

concern without experience, whereas Baritina was and

_ had been an established and going concern,

4, The -various-manufacturing costs of the saedeats < 4

involved, the _gross profit involved in the sale of such

products based upon ‘such known manufacturing costs

and the known selling prices of the products,

5. - The high cost of operating in Venezuela and Co’

lombia*known to the petitioner’s management from

information furnished to the petitioner. by Baritina,

- and _ , & |

6. : That it would. be necessary for Oil Base de

- Venezuela to appoint subagents or distributors in var-

ious foreign countries and to pay them cotnmissions

on salés made in those countries.

_» During the yéar in question Oil Base ede Venezuela

had subagent or distributorship agreements in effect

covering ithe countries of Colombia, Peru, and Mexico.

‘

. ; er

These subagent or distributor agreements provided for

rates of commission, approximately equal to those which

had been in effect in the agreement ‘between petitioner

and Baritina.

Certain of the petitioner’s employees rendered serv-

. ices for Oil Base de Venezuela, and by reason of an

agreement between the petitioner and Oil Base de Ven-

-ezuela, the compensation of such employees for the:

time spent rendering services for Oil Base de Vene-

zuela and any expenses incurred i in such connection were

borne equai'y by the petitioner and by Oil Base de Vene- .

zuela and proper charges were made on the books of

account of both corporations.

The petitioner’s direct profit sf, sales for its fis-"

cal years ending in 1956, 1957, 1958, and 1959 ex-

pressed as ‘a percentage of gross sales from the stand-:

point of total sales, domestic sales. and export sales

were as follows:

Period - yw = eae R cs ;

Ended 9-30-56 9-30-57. 9-30-58 9-30-59.

Total 24.7% 21.6% 32.0% 23.0%

Domestic ‘© 224% 14.0% 21.2% ~ ° 225%

Export 34.6% 30.1% 45.6% —-23.9%.

The percentages expressed above represent the direct

profit after deducting from gross sales all discounts

and commissions allowed, the manufacturing costs of

.the goods sold, any patent royalties paid with respect

to the goods sold, and the direct selling expense, which

includes salesmen’s salaries, traveling and entertaining

expenses.

The results of Oil Base de Venezuela’s operations -

for the three and one-half (314) month period ended

dainities 30, 1958, and for: the full year ended Sep-

‘tember 30, 1959, are as follows }

Period Ended eH gtsg cae 8 9-30-59

Sales: ” oe ae $192,424.

Cost of Goods Sold - 12,297, 130,451.

‘Commission Income " . 18,705. °. 99,933. _

Other-Income ~ "450. 4,800.

Expenses - | 9,392 — 82,675.

Net Income ———~" 18,208. 8 Ae..

3 3% _ month period

, The results of Oil Base de Veranuits’ S operations

for the years ended ‘September. 30, 1960, 1961, and

. 1962 are as follows:

Period Ended - 9. 9.30.60 9.30.61 | 9-3062'-

Net Sales and Service .

Income 149,684. 78,400. . 31,697.

‘Costs and Expenses 147,497- 90,717. . ‘41,387.

Other Income ; 4,683. | 13,022. 16,595.

Other Deductions. ~ . 6,778. 1,199. 10,501.

Net Profit. (Loss) 92. 494.) (3,596.)

The results of. operation which is referred above

were based upon statement prepared by Oil. Base de

Venezuela’s certified public accountants and submitted,

by Oil Base de Venezuela to the petitioner. Such re-,

“ports came to the petitioner in terms of the Venezuelan

currency, which is the bolivar, and for the purposes of

the proceeding below were converted: to dollars at the

rate of three and one-third (314) bolivars to. one United

States dollar.

During ‘the fiscal year in question, i.e., Sepeewiber

30,1959, Oil Base de. Venezuela paid a in-

come taxes in the amotnt of $2, 78

For the petitioner’s fiscal year ended September 30,

A959, the Commissioner of Internal’ Revenue determined

fe .

duction of roughly 89.31%.

—10— :

that commissions paid, and discounts ‘allowed by peti-

tioner to Oil Base de Venezuela with: respect to sales

of petitioner’s products within ‘Venezuela were exces-

sive to the extent they exceeded those which would

have been paid4or allowed’pursuant to the rates of

-- Commission, discount which prevailed under the:

Baritina ontract, and reallocated such alleged excessive

amounts to petitioner’ under the provisions of Section

482: of the Internal Revenue Code. Further, the Com-

_ missioner of Internal Revenue entirely disallowed as de-

ductions all commissions paid by petitioner to Oil Base

de Venezuela with respect to sales of petitioner’s prod-

“ucts outside of Venezuela.

The Tax Court below: whose decision was affirmed :

by the ‘Court. of Appeals sustained the Commissioner

of Internal Revenue’s determination insofar as it had

. reference to the commissions paid and discounts allowed —

on sales within Venezuela, but allowed the petitioner

deductions for commissions .paid on sales outside Vene-.

_zuela in an amount equal to those which would have

been paid pursuant to the commission rates prevailing 4 a

in the Baritina -contract.

That portion of the determination of the Commis-

sioner of Internal Revenue which ‘was sustained by° :

the Tax Court and the Court of Appeals had the ef-

fect of reducing the profit of Oil Base de Venezuela

from $81,031 to approximately $8,666, a ‘percentage re- °

‘This case .was tried originally Th. the Tax Court of

the United States pursuant to. the provisions of 26

~ US.C. Sections 6213, 7442, 7 .

yt 3 Sallie

Reasons for Granting the Writ.

The decision - of the. Court of Appeals below com-

_ pounds the confusion already existing in an increasingly |

important area of federal law, that of federal taxation

‘as it. relates to international business operations. The

question ‘involved badly needs the consideration and de-

finitive determination of ‘this Court. A recognized au-

_ thority in this area of federal taxation writing in the

7 Proceedings of the . New York University ‘Twenty

Fourth Annual Institute on Federal ‘Taxation at page

1433 states as follows:

“A discussion of inter-company pricing issues at

this stage if the development of the law is very

much a shot ‘in the dark. Although the Treasury

Department has promised regulatory guidelines in .

the area, these have not appeared as of this writ-

. ing. The history of section 482 and its predeces-

sor provision has provided a scattering case law,

but much of this seems in conflict—on method-

ology, as well as substantive result. Attempts to rec-

oncile decisions | obviously stemming ° from basic ©

: ‘differences in outlook by individual judges may

only ‘be misleading. It is probably wiser to rest with

the uncomforting conclusion that the decisions are

not all guidelines, or at _— not all equally good

ones. \ °

- At the same time), there ns testi a great sutge

in audit activity by the Internal Revenue Service

in this area. Particularly since pricing casés are

among ‘those in which Revenue Procedure 64-54

leaves the Service free. to proceed for pre-1963

years, ‘there is a wide and growing field of law

_. building up. The Institute ‘has presented able ‘pa-

_ pers on this subect in the past; and only this

broadening importance of the subject -‘matter,) plus

two or three interesting developments since the —

latest presentation, justifies this new: treatment.”

Even since the paper in which the. above quotation ©

appears was written (early 1966). the Internal Reve-

‘nue Service has on April 1, 1966 published proposed

Regulations to section 482 of the Internal Revenue —

Code, has on August 2, 1966 withdrawn those proposed .

Regulations published on April 1, 1966 and published

new proposed Regulations to section 482. Federal Reg-

ister, August 2, 1966. Additionally, the Internal Reve-

‘nue Service announced on August 2, 1966 that the In-¢

ternal Revenue Bulletin of August 22, 1966 will con-

tain Rev. Proc. 66-13 and an amendment to Rev. Proé. -

65-17, 1965-1 C.B. 833, both of. which deal with prob-

lems concerning the allocation of income, etc. between

a domestic corporation and its controlled foreign cor-

poration. See Technical Information Releases Nos. 836

and 837. Also on August 2, 1966 the Internal Revenue

Service announced its reason for acquiescence in Smith-

Bridgman .&.Co. 16 T.C. 287 and explained its: posi-

tion in* regard to: Tennessee-A rkansas~Gravel Co., 112.

F. 2d 508 (CA-6, 1940); both of which cases deal

- with allocation under the precursor of section 482. The

attention now being given this area by the Internal

“Revenue Service clearly demonstrates that not only is.

this an important area of tax law admiinistration but

also that substantial confusion exists with respect to it.

- Both the- federal ‘officials charged with the duty of

administering the tax laws and taxpayers attempting to

‘frame business traisactions in’the light thereof .are en-

tien ee

.°@

titled to an at to this éonfusion and more definite

guidelines. Only this Court can.do this.

Section . 482. of the Internal Revenue Code of 1954

has been a part of the Internal Revenue Code since

the Revenue Act of 1928; and has remained substan-

tially - unchanged since that time.+ The section is set ) ¢

forth verbatim at page 2 hereof.

The report of the Ways and Means Committee on”

the Revenue Act of 1928 describes the evils: which sec-

tion 482 was designed to correct:

The section of the new Bill provides that the

Commissioner may in the case of two or more

trades or businesses owned or controlled by the

same interest, apportion, allocate, or distribute the |

income ‘or deductions between or. among them, as

_ may be: necessary in order: to prevent evasion (by |

the shifting of profits, .the making of fictitious

sales, and other’ methods frequently adopted for

the purpose. of ‘ ‘milking”’) and in order clearly to,

reflect their true’ liability.”

i Accordingly, the underlying’ practices-at which sec-

tion 482 was aimed were “the shifting of profits, the

‘making of, artificial sales” and- other similar devices for’

“milking” trades or businesses of profits.

’ The authority granted to the Céininissioner of In-

ternal Reveriue in section 482 and its predecessors has

been exercised by -him -in two basic situations. “One,.

iSection 45 of the Taterntl Revenue Code’ of ‘1939 was .

amended by section 128(b)' of the Revenue Act of 1943 to

delete the words “gross incorfe or deductions’*and substitute

. therefor “gross income, deductions, credits, or allowances.”

2H. R.. Rep. No. 2, 70th Congress, First Sessidn 16 ( 1927) ;

S. Rep. No. 960, 70th _ Congress, First’ Session 24 Lace

Ls ° *

Jf . . . . i :

; 4

° ; ; z

= S< - Mg

i @ ’ @

’

in those cases involving transactions between controlled

taxpayers where no sound business purpose exists, and

two, in cases dealing with transactions between con

trolled businesses where a soundabusiness purpose does ;

exist, but which are allegedly consummated with tgo

great a tax advantage. In the former situation an al-

location ‘has been made which has the effect of com-

pletely ignoring a taxable thtity where there appears to

be no business purpose for’ its existence. In the latter

situation, allocations are made ‘by the’ Commissioner.

to achieve what he. considers to be a clear: reflection of

the taxable income of the controlled businesses. In sit-

uations where all of the contrdlled : : businesses ‘are sub-

ject ‘to United States income taxation, the tax effect of

the allocation on one of* the controlled businesses is”

usually of fset either sooner or later by the reciprocal ad-

justment to re taxable income of ‘the other controlled

business or businesses. In situations, however, where

‘one or more of the controlled businesses is subject to

United States income taxation and one or moré of the

controlled businesses is not, great harm can be done and

the Commissioner’ of Internal. Revenue should be re-

quired to exercise his authority with utmost caution..

~ Although the statute itself establishes no Rich. stand-

ard, and although no‘such standard can be derived from _

"any statements of Cgngressional intent, the Commis-

sioner of Internal Revenut takes the position that the

standard ‘to be applied in every case where ah alloca- |

* tion is. to be: made between controlled businesses is that

of an uncontrolled taxpayer dealing at arm’s length

. with another uncontrolled taxpayer. Incorne Tax Regu-

dations Section 1.482-1(b) (1).

oY oe |

. In Frank v. International Canadién Corp., 308 F. 2d

520 (C.A. 9, 1962) the Court of Appeals - for the

Ninth Circuit had before it a question of an allocation

of income by the Commissioner of _ Internal Kevenue

pursuant to Sectiog 45 of the 1939 Internal Revente

Code. between a domestic parent corporation and its» -

wholly owned Western Hemisphere trade: corporation.

In the Frank case the es acl (referred to herein as”

“Pennsalt”) was a manufacturing corporation It or-

ganized a Washington corporation ’( International) for

the sole purpose of selling certain of Pennsalt’s, products ”

to Canadian customers. These products: had previous-

ly been sold to, such Canadian customers by Pennsalt

itself. It was the intention of Pennsalt -in forming In-

ternational that the latter would qualify as a. Western

‘Hemisphere trade corporation within the meaning of

‘Section .109 of the 1939 Internal Revenue Code. The

specific question involved was whether or not'the prices

which Pennsalt charged International for the products

which International purchased from Pennsalt and in -

turn sold’ to the ‘Canadian customers were such ag to

distort the true income of the controlled corporations. —

The Commissioner’ of Internal Revenue, of course, con-

tended that the price structure for the products involved

should have been that which would have resulted from

bargaining between the parties dealing at arm’s length. :

‘The District Court in this tase, howeyer,: “had found that

the price structure resulted ina Teasonable fate of re-

turn being received by Pennéalt, the manufacturing cor+

poration, and that such was sufficient for the purpose

of determining — the true net income of the controlled

corporations. ‘>

| | —16—

The Court of Appeals in the Frank case in speaking

with respect to the Commissioner of Internal Reve-

nue’s arm’s length bargaining argument, stated as fol-

lows :

, “But entirely aside from the appellee’s position

that the Commissioner fs precluded from advancing

this argument on appeal, we do not agree with |

the Commissioner’s contention that ‘arm’s length’

bargaining’ is the sole criterion for applying the -

statutory language of section 45 in determining

what the ‘true net income’ is of each ‘controlled

- taxpayer’. Many decisigns have been reached un-

der Section 45 without reference to phrase

‘arm’s length barggining’ and without reference to

Treasury Department regulations. and ms

which state that the talismariic- combinat of

words—‘arm’s length’—is the standard to be ap-

plied in every case.

. “For ‘example, it. was not ‘any less proper for

the District Court to use here the ‘reasonablg re-

turn’ standard than it was for other Courts to use

‘full fair value’ ‘fair price, including a reasonable

° profit’ ‘method which seems not unreasonable’ ‘fair

consideration which reflects arm’s length -dealing’

‘fair and reasonable’ ‘fair and reasonable’: or ‘fair

and fairly arrived at’ or ‘judged as to fairness

all used in interpreting Section 45.” (308 F. 2d at

528-529). :

In a footnote this Court then cites the following

cases as supporting the second paragraph of the above

quéted portion of the decision. ;

The Friedlander Corp., 25 T.C. 70, 77 (1955);

7 —17— ;

Grenada Industries, Inc., 2? te: 231, 260

(1951). Affirmed 202 F. 2d 873, certiorari

denied 346 U.S: 819;

Motors Securities €o., JInc., 11 T.CM.. 1074,

4 1082 (1952); : | | we

Palm Beach Aero Corp., 17 T.C, 1169, 1176 |

(1952); =‘ a ae

Polak’s Frittal Works, 7 21 TC, , 953, 975-

' 976 (1954); and ‘

Seminole — Co., 4 T.C. 1215; 1232 (1945).

In making the statement. quoted above, the Court of

Appeals in the Frank case ‘was not speaking strictly

‘within the confines of the facts before it in that case. .

It was, on the other hand, enunciating what it consid--.

ered to be an established rule of law based upon’ the

cases which it cites in support thereof. The Frank case

‘clearly. stands ‘for the proposition that if a taxpayer

meets either the “fair and reasonable” criterion, or the

“arm’s length bargaining” criterion, the Cornmissioner

may not reallocate. incomie ‘deductions, etc., under the

eprovisions of Section 482.

It-is also clear that the Congress believed and un-.-- .

derstood that the standard under, Section”482 with re-. ° _

spect to inter-company sales to be a fair ér reasonable

price. This-is. clearly eviderfced by the following state-

ments made by the House Committee on Ways and_

Means when'in 1962 it was.-studying the effect of

Section 482 ini the specific area of inter-company pric-

—lCltC~« eA 3

“Present law in Section 482 authorizes the Sec-

retary of tne Treasury to allocate income between .

related organizations where he determines this ‘al-

a“

’ —1&a— , : -

- location is necessary ‘in order to prevent evasion

of taxes or Carly to. reflect the income of any

such organizations.’ This. provision appears to give

the Secretary the necessary authority to’ allocate

income between’ domestic parent and its foreign

subsidiary. Howe er, in practice the difficulties in

determining a fair price under this provision severe-

ly limit ‘the usefulness of this power, especially

where there thousands of different transactions

engaged in between domestic company and its for-

eign subsidiary.” (Emphasis added).*

‘In the instant proceeding below the petitioner es- .

tablished that in making domestic sales of its products, :_

it sold directly to its customers thrqugh its own selling ~

_ personnel. With respect’ to its export sales the petitioner:

established that it sold through sales representatives

who received a discount or commission with. respect to

such ‘sales. The petitioner further established that de-

spite the, rates of commission and discount which were

paid or‘ ‘allowed to Oil Base de Veneztiela, which the

Commissioner ‘of Internal Revenue deemed excessive,

the return on its manufacturing activity with respect

to export sales was equal to or greater than the re- 7

turn on ‘its manufacturing activity with respect to do-

mestic: sales. The petitioner contended, therefore, that

its transactions with its foreign subsidiary were “fair |

and reasonable” sirfte the’ price it received for manu-

facturing’ the products which were sold’ abroad, pro-

duced for it a return which was equal to or greater

3H. R. Rep. No. 1447,- 87th ——- Second Session, ‘28

(1962). .

than the return on its manufacturing activity with re-

spect to products which were sold to unrelated parties.

In the instant proceeding the Court of Appeals be-

low in commenting, on its prior decision ‘in the Frank

_ case states that the Frank case did not hold that the

arm’s length standard established by Regulation -was

_ improper. The petitioner. does not so contend. The Court

of Appeals below further notes that the Frank case

held that the arm’s length staridard ‘was ‘not “the sole

criterion” for determining fhe true net income of each

controlled taxpayer, and then goes on to state:

“However, permissible departure from the Regula-

tions’ arm’s length standard was under the facts

of that case very narrowly limited.” ;

It ig respectfully submitted by, the petitioner, however,

that the enunciation of the Court of Appeals in the

Frank case that the arm’s length standard was not the

sole criterion was not made solely with reference to the

- facts of the Frank case. It was stated as a basic propo-

sition of law, and as stated above, the clear implica-

tion is that if a taxpayer satisfies either of such cri- _

terion, the Commissioner may not reallocate under Sec-

tion 482.

The holding of the Court of. Appeals in the. instant

proceeding below substantially obscures the state of

Jaw in this: area.. The Commissioner of Internal Reve-

nue in his Regulations continues’ to take the position

that the standard to be applied in every case is that

of an uncontrolled taxpayer dealing at arm’s length

—,

with another uncontrolled taxpayer. The clear —on ;

of the Court of Appeals in the Frank case was that

this was not the sole criterion, but that the taxpayer

would prevail if it could show that’ its~dealings- with...

its controlled business were fair and reasonable. In lim- _

‘iting the application of the fair and reasonable doc-:

trine, the Court of Appeals in the instant proceeding.

creates such uncertainty in the area of inter-company

pricing in international business operations, as to pro-

foundly affect the conduct thereof.

A further question which begs clarification By this

Court is whether the authority granted to the Commis:

sioner of Internal Revenue by Section 482 is such as

to permit him to create a loss in one of the controlled

businesses. |

In the instant proceeding the elite catia }

in the Courts below,that the same agreenient between

the petitioner and Oil Base de Venezuela, including

the rates of commission and discount, which the Com- —

missioner of Internal Revenue deemed excessive, was

in effect not only during the year. before the Courts

below, that being the petitioner’s fiscal year ended Sep-

tember 30,1959, but also during. the fiscal years: ended

in 1960, '1961, and 1962. As shown in-the Statement

of the case in ‘this Petition, Oil Base de Venezuela for’

its fiscal year ended in 1960 showed a net profit of ‘-

Ninty-Two Dollars ($92.00). For its fiscal year ended

_. in 1961 it suffered a loss of Four Hundred Ninety-

Four Dollars ($494:00), and for“its fiscal year ended .

in 1962 a loss of Three Thousand Five Hundred .

Ninety-Six Dollars ($3,596.00). The foregoing are the

“results of Ojl Base de Venezuela’s operatiorts prior to

the reallocation of income made \Py the Commissioner

et tetene i)

. changed to a loss, and the losses which it suffered in:

the fiscal years ended in 1961 and’ 1962 will be sub- |

8 .

—21— Ps

of Internal Revenue. It is. readily apparent that if the

basis of reallocation maidé by the Commissioner of‘ In-

ternal Revenue in the fiscal year ended in 1959 is ap-

plied to the three ensuing years, the small profit which

it realized in its fiscal year ended in 1960 will be

stantially enlarged. At the same time, the taxable net

income of the petitioner is correspondingly enlarged. In

comparing the operating results of the two corporations

on a consolidated basis, both before and after the re-

allocation "proposed by the Commissioner. of Integfial ~

Revenue, it would appear that the Commissioner is

creating income taxable by the United States where in

fet none actually exists. ° .

Additionally, assuming arguendo that: arm’s length

bargaining i 1s the standard to be applied in every case,

can it be said that parties dealing at arm’s length would

enter into transactions which would force one of the |

_arm’s length bargaining parties to operate at a loss?

It is submitted that the question supplies its own an-

swer. — e (Shey 3

Accordingly, it ‘is respectfully submitted that the

Congress in granting.to the Commissioner of Internal

Revenue the power to reallocate certdin| items of income

deductions, etc., did not intend to confer upon the Com- |

missioner the power to force one ‘of the controlled tax-

- payers to operate at a loss while i increasing the income

of the other controlled. taxpayer; that the instant pro-

ceeding is a glaring example of the fact: that the*Com-

‘ missioner is exercising: such power to such effect, and

it is further Sabmitted will continue to do so unless this

Court places a limitation upon such power.

re . 4 ‘. % 2 ;

Conclusion. — wt

.A question of ever increasing importante. in the ad-

ministration of the, Federal tax laws and the ability of

the business community to frame international busi-

ness transactions in the light thereof has been thrown

into an even greater state of confusion by the decision

_ of the Court of Appeals for the Ninth Circuit in the

instant proceeding. Only this Court can end this con-

fusion, and create ‘an environment of reasonable cer-

tainty within which international business operations

can be conducted. We urge the Court, therefore, to ©

grant the Writ of Certiorari.

Respectfully submitted,

WILson B. CopEs,

WELLMAN P. THAYER,

4 1ttarneys for Petitioner.

at te ial

(A ied eed ao

et =o Be ers

BS ono

‘ternal Revenue, Respondent. No. 20,073.

-*APPENDIX IT: —

Judgment.

' United States Court of Appeals For the Ninth Cir-

cuit.

“Oil Base; Inc., Petiicner, VS. Commissioner of In-

Upon, Petition to Review a Decision of The Tax

Court of the United States, *

This Carjse came on to be heard on the Transcript ©

"of the Record from ‘The Tax Court of the ‘Vatted

States, and was duly submitted.

On. Consideration Whereof, it is now here dedeted

and adjudged by this Court, that the Decision of the

‘said Tax Court of the United States in this Cause be,

and hereby is affirmed. ; |

_ Filed and entered May 23,. 1966.

APPENDIX II.

" Opinion of the United States Court of Appeals. »

for the Niath Circuit.

“United States Court of Appeals, for the Ninth Cir- *

cuit. Vv:

Oil Base, omy Petitioner, vs. Commissioner of ‘In-

ternal Reyenue, Respondent. No. 20,073.

- [May 23, 1966]

On Petition for Review of a Decision of the Tax

NN Court of the United States. eg

\ Before: Merrill and “Browning, Circuit Judges, and

T ‘hotmpson, District Judge.

Merrill, Circuit Judge:

se]

Petitioner as taxpayer seeks review:of a ‘Pax Court

decision respecting income taxes for the taxpayer’s’

fiscal yaar ending. September 30, 1959. Phe tase in-

volves allocation of itteome between the taxpayer and

its subsidiary, a wholly owned, Venezuela corporation, ;

Oil Base de Venezuela, C.A. (hereinafter referred to as

“Obvenca”), which, during ‘the yeay in question, served

as taxpayer’ s foreign sales representative.

bead ifcome derived by Obvenca was attributable to

commissions and Sues allowed by the-taxpayer pur-

suant ‘to an ‘@ereement between the two companies.

Finding” these commissions and discounts to, be roughly

twice as: large asathose paid ‘or allowed: “by taxpayer in

agréements with five separate uncontrolled foreign sales

representatives (including Obvenca’s Venezuelan pred- .

ecessor and three -of Obvenca’s subagents), the Com-

missioner, under section 482, Internal ‘ Revenue Code

of 1954," rejected the terms of the agreement as not

clearly’ reflecting the income of the parties and having

the effect of imptoperly shifting incgme from taxpayer

to its controlled foreign subsidiary. Pursuant to Treas-

ury Regulations’ the Commissioner allocated to taxpay-

er that income which the arm’s-length arrangements

ae : ;

‘Internal Revenue Code of 1954: «

“SEC. 482. ALLOCATIONS -OF INCOME AND DE-

DUCTIONS AMONG TAXPAYERS.

In any case of two or more organizations, trades, or

businesses (whether or not incorporated, whether or not or-

ganized.in the United States, and whether or not affiliated )

owned or controlled directly or indirectly by*the same in-

terests, the Secretary or his delegate may distribute, ap-

portion, or allocate gross income, deductions, creditsSor al-

‘ lowances between or among such organizations, trades, or

businesses, if. he deterrhines: that such distribution, appor-

tionment, or allocation is necessary in order to prevent

. evasion of. taxes or clearly to reflect the income ‘of an

such organizations, trades, or: businesses.”: (26. U.S.C.. 19

ed., Sée. 482.)° ' ’

#Section 1.482-1(b) provides in part: * |

“Scope and purpose. (1) The purpose of sectidn 482 is

to’ place a controlled taxpayer on a tax parity with an

uncontrolled taxpayer, by determining, according to the

/ ' standard of an uncontrdlled taxpayer, the true taxable income

from the property and business of a controlled taxpayer.” ”

Section “1:482-1(a)(6) provides’: ,

gthe term ‘true taxable income’ means, in the case of a

controlled taxpayer, the taxable income (or, as the’ case

may he, any item or element affecting taxable income) which.

would have resulted to the controlled taxpayer, had it in. the

conduct of its affairs (or, as the case may be, in the par-

ticular contract, transaction, arrangement, of other act) dealt

with the other member or members of the group at arm’s

length. It does not mean the income;. the deductions, the

e credits, the allowances, or the item or element of ificome,

g deductions, credits, or allowances, resulting to the controlled

'. taxpayer by reason of the particulas contract, transaction, ‘or |

- arrangement, the controlled taxpayer, or the interests con-

trolling it, chose to make (even though such contract, trans-,

action, or arrangement be legally binding upon the parties

thereto) .” :

g: *.

Poe, an

with uncontrolled foreign sales representatives would

have produced.* The Tax Court supported the Commis-

sioner. We agree. | ,

As stated by the Tax Court in its opinion:

“The -burden is on petitioner to show error in re-

spondent’s allocation and respondent's determination

must be stistained unless it is unreasonable, arbi-

trary or capricious.”

-, Taxpayer contends here, as it did before the Tax

' Court, that the Commissioner has erred in establish-

ing by regulation and using here a standard of arm’s- —

length bargaining. Taxpayer points out:that no such

standard is‘contained in the statute. ‘It; contends that

under the statute thé question. is not what income arm’s-

léngth bargaining would have produced, but what in-

come properly is attributable to each of the two com-

monly held corporations as its true net income in light

of what each performs’ or produces. Relying on this ©

court’s decision in Frank v. International Canadian

Corporation, 308 F.2d 20, 528-529 (9th Cir. 1962),

~ *The Comatestonss explained his adjustment to the taxpayer .

as follows:

“It is determined that commissions ‘paid and discounts

oe to your ‘controlled foreign subsidiary, Oil Base de

of Veneuda, CA, vere “dome fr Solar codeine’

i ing rom you to cont

foreign subsidiary, thereby distorting your and the

were paid to Oil Base de Venezuela on certain sales occur-

ring outside of Venezuela which were, in substance, your

and on these sales no commissions are being allowed

this determination. In determining the

allowable as commissions and discounts paid. 3 Oil Base

i ieee. CA, chat cin amnels to.enpitly anette,

the determination has been based on arm’s length negotiated

rates between yourselves and uncontrolled parties on- identical

and services. This issue involves application of sections

1 and 482 of the Internal Revenue Code df 1954.”

it contends that in the present case the question is

whether the income reported by taxpayer is a fair and

reasonable, return on its retained manufacttiring acti-

vity.! ,. =a *

We cannot agree. Where, as here, the extent of the

income.in question is largely determined by the terms

of business transactions entered into bétween two ‘con-

trolled: corporations it is not unreasonable to construe

“true” taxable income as that which would have resulted

if the transactions had*taken place upon such terms

as would have apphied had the dealings been at arm’s

- length between ‘unrelated parties. eet: ‘°

Frank v. International ‘Canadian C or poration, supra,

did not hold that the arm’s-length standard established

by regulation:was improper. It held that it was’ not’

“the sole criterion” for determining the true net income

of each controlled taxpayer. However, permissible de-

parture from the regulation’s arm’s-length standard

was, under the facts’ of that case, very narrowly

limited® and the holding has no application to the facts

before us. |

*Taxpayer asserts that this has been conclusively . established

by proof that even after payment of the commissions and ‘al-.

lowances of the. discounts in question, it has realized a higher

return on its manufacturing activity in respect to foreign sales

than it has in respect to its domestic sales. The Tax Court

dismissed this contention with the comment: -

“There is no evidence to show that the percentage return

retained by petitioner on domestic: sales would represent a

reasonable return on its export sales.” ity

*It was held: (1) that where the pretrial order pursuant to’

stipulation specified that the.standard to be, applied was “rea-

sonable price and profit,” the District Court was not in error in

applying that standard; and (2) that the court was not in

error im holding the price and profit to be reasonable where (a)

the price charged resulted.in a reasonable return to the retained

manufacturing. activity, and (b) there was no evidence that

(This footnote is continued on the next page)

’

satis

We conclude that the arm’s-length bargaining stand-

ard was properly applied pursuant to —e Hall v.

Comm’r, 294 F.2d 82 (Sth Cir. 1961). . :

Taxpayer contends that certain Sestirs bearing on

Obvenca’s business activities distinguish its situation

- from that of its predecessor and render the arm’s-length

history irrelevant.and its return inadequate. It contends

that adjustment should be, made to compensate for these

factors and, that .doubling the commissions and dis-

counts previously paid was reasonable adjustment.

The Tax Court considered these factors and rejected '

taxpayer’s contentions with respect to them. _For the |

reasons expressed by the court we do not regard this |

ruling as arbitraty or unreasonable under the circum-_—

‘ stances.

Affirmed.

be]

arm’s-length bargaining upon the specifi. commodities sold had

produced a higher return. Further, fromthe complexity of the

circumstances surrounding the services rendered by the subsidi-

ary it appears that it would have been difficult for the court

to hypothesize an arm’s-length transaction.

APPENDIX Ik ©

Memorandum Findings of Fact and Opinion.

| T. C. Memo 1964-298

Tax Court of the United States

Oil Base, Inc., Petitioner, v. Commissioner of In-

ternal Revenue, Ruisdelen Docket No. 2289-63.

Filed November 17, 1964. + |

.. Wilson B.C opes, for the petitioner.

John W. Alexander, for the respondent®

‘Scott, Judge: Respondent determined a deficiency in -

‘petitioner’ s income tax for its fiscal year ended Sep-

tember 30, 1959, in the amount of $51, 718.66.

| The i issues ie decision are:

(1) Whether respondent properly included in peti-—

tioner’s income under the provisions of section 482 of '

the Internal Revenue Code of 1954 a portion of the com-

missions paid and discounts allowed to petitioner’s *

wholly owned foreign subsidiary.

(2) Whether’ respondent properly disallowed peti-

tioner’s deduction for all commissions paid to its wholly

owned subsidiary, on sales of petitioner’s products in

countries other: than Venezuela.

FINDINGS OF FACT.

. Some of the facts have been stipulated and are found

accordingly. °

Petitioner is a California corporation with its prin-

cipal place of business in Houston, Texas.

_ Petitioner’s income tax return for its fiscal year ended

September 30, 1959, was. filed with the district director

of internal revenue for the Sixth District of California.

5 .

» :

During its fiscal year 1959 petitioner’s principal

place of business was in Campton, California.

Petitioner is and has been. since prior to 1946, en-

_ gaged in the business of manufacturing and selling oil

base drilling fluid and related pemucts ¢ to the oil ha

- ing industry.

( o>

Sincé approximately 1946 petitioner has been selling

its products in certain foréign countries where oil drill-

ing activity was being conducted.

Petitioner’s principal product is an oil base drilling

fluid known as ‘Black Magic.” Black Magic i is a special-

* ized product for use in the, oil drilling industry possess-

ing certain qualities,not found in water base drilling

’ fluids: It: produces highly desirable’ results in certain

specialized oil well drilling situations. The product is

more expensive than water base drilling fluids and, is

dirty and disagreeable to work with: For this reason.

petitioner considers it necessary to direct its selling ef-

forts to all levels of oif drilling personnel ranging from

the top production executives of an oil company down

to the drilling crews. Generally, it requires more than ©

one contact to’ result in a sale of petitioner’s product.

Service of the use of petitioner’s products after a sale

is also an important feature of petitioner’s business.

Petitioner maintains a staff of service enfitcers whose

main duty: is to service and supervise the use of its

products by its customers. All of’ petitioner’s sales and

service engineer® are trained in the use of petitioner’s °,

products and» petitioner’s top executives are. ne

trained. /

A true oil base drilling fluid j is weed i in niienteidecey

2 percent of all oil wells drilled. Thare are several

ie:

companies which manufacture and sell a trie oil base

drilltng fluid, and these companies other than petitioner

are’ petitioner’ s direct Competitors.

Prior to’ October 1, 1955, petitioner’s foreign sales

had been accomplished’ tnreagh various independent

sales representatives.

_ On or about October 1, 1955, petitioner and Batitina.

de Venezuela, S.A., a Venezuelan corporation of Car-

acas, Venezuela (hereinafter referred to as Baritina),-. |

. executed an agreement gursuant to which Baritina was

to act as the exclusive sales representative for peti-

tioner’s products in the country of Venezuela. This

_ agreement’ provided that Baritina would diligently and

. faithfully prosecute the sales of petitioner’s products

and would forward to petitioner all orders to be shipped

_by petitioner directly to Baritina’s customers, that Bari-

tina would.pay its own costs and expenses and: would

maintain at its own expense ‘an adequate and competent —

staff of sales engineers in connection with the selling

‘and servicing of petitioner’s products. It further pro-

_ vided that Baritina would send one or more persons to

petitioner’s Compton plant for instruction in the use

and ‘sale of petitioner’s “products. The agreement: also

_ provided that Baritina would not sell or attempt to sell °

arty product similar to petitioner’s products * without

‘ petitioner’s consent. The agreement contained* in addi- |

tion other general provisions prith respect to liabilities:

of the parties, claims, and prices of merchandise, and

it contained the foltowing provision with respect to. Bari-

tina’s commissions and discounts: ~ .

8. First Party (OIL BASE; INC.) agrees’ to

pay to Second Party [Baritina] as commissions ,,

ypon merchandise shipped directly by First Party

f “—1lo—

to the consumers within Second Party’s territory,

as hereinafter set forth under heading (a) of this

paragraph contained; First Party does further

agree to allow Second Party discounts from its list

"price of merchandise hereinafter listed as may be

purchased by Second Party from First Party for 2

resale and stocked or warehoused ‘by it, as herein-

after set forth under headings (b) and (c) of this

paragraph contained; |

(a): " (b) Ac) *

Net 90 days Net 90 days

. . fromdate from date

. ofinvoice — of invoice

a (commission) (discount) (discount)

- OB Wate 15% 17% - 20%

Filer Presses 15%. 7% 2%.

Chemical “V”’ 15% — 174% 20%

OB Zero - 15% . 17Y%% 20%

- Mix Fix | 15%: 17Y%z% 20%

- . Additive “E” 18%.° 174% * 20%

_ Sacked Black | ° ek:

Magic « 20% j§§ 22%4% © 25%

OB Gel 20% - 22290 25% |

'- OBGen © 20% — 22Uu% " 25%

White Magic - 20% . . 22%% 25%

Economagic 20% © 2214 % 25%

Peptomagic ° 20% 221% : 25%.

No-Glo Oil 20% 221%4% 25%

No-Glo .. 200% ~. 224u%% “25%

Thread

~ Lubricant

‘ Special , : :

Q» Additive 58 200% . 22U%% .- 25%

Formaseal 20% . 22U% 25%

-MudGuns ° 20% 22Y% #.. 25%,

Well Wash 20% ' 22Uu% 25%

Chemical - : trees

Pes ie | 20% * 22Y%- . 25%

Black Magic

' Premix 20% j§§ 224% . 25%

Hand Gleaner *. 20%’ ) »22Y% 25%

_ tina &xecnted a document gntitled Sup

ili,

The foregoing may be amended in writing endorsed

thereon.

“On or about December 1, 195

titioner and Bari-

mental Agree- |

ment” pursuant to which sth’ ‘country,. of Colofibia was

added to the territory for which Baritina was to be the

exclusive representative of petitioner’s products. This _

supplemental agreement: surther provided that AZ Ex-”

port, S.A., a corporation, Was to be named as the

exclusive subagent and distributor of petitioner’s prod-

ucts-in the Republic of Colombia. *

The agreement between petitioner and Baritina with

the. supplement including sales: im, the Republic of |

Colombia, remained. in “force through September 30,

1957. ,

After September 3Q, 1957, and during the period of

~ time in which Baritina and. petitioner were negotiating.

in an effort to reach a new agreement Baritina con-

» tinued to’ sell petitioner's products, even though -no

written contract in this respect between the two parties

was in effect.

Prior to October 1, 1955, while petitioner was. repre-

” sented by indeperident sales representatives in selling

its products in foreign countries petitioner sent per-

sonne]_ from its own plant to assist its sales representa- -

‘tives in the sales and servicing of petitioner’s products

even though some of the sales representatives had _per-

sonnel who had been trained i in the uses and applications:

of petitioner’s products.

' During, the time that Baritina was representing peti- —

tioner, petitioner furnished Baritina one of its own ex: -

perienced engineers who went to Venezuela and becatne

Cxdfnw

employed by Baritina. This. engineer while employed by

Baritina, worked primarily on sales of ° petitionet’s _

products. | 5

After the termination of the agreément between peti-

tioner and Baritina on September 30, 1957, the two com- -

panies negotiated for the renewal and modification of

the agreement. These. negotiations. consisted of cor- |

‘respondence between the two companies, and represen-

_ tatives of petitioner and a representative of Baritina

had’ one personal conference. The personal conference

took place in petitioner’s offices at Compton, California,

and petitioner was represented by i its president and exeg-

utive -vice president, and Baritinz by its assistant gen-

- eral manager. Petitioner’s representatives in these ne-

| gotiations, took the position that since ‘40 percent of

Baritina’s stock has been acquired by. National Lead

Company, which operated a division, called .the Baroid

Division which was a direct competitor of petitioner,

petitioner should have protection with respect to the

\. time period of the contract and quantity of inventory

carried by. Baritina. In addition, petitioner wanted Bar-

_ itina to erect.a premix plant in order. that petitioner’s

_ products might be shipped in a dry state to Venezuela

and. mixed in fiquid form ‘in that country. Petitioner

also wanted Baritina to agree to send four or more per-

sons to its plant at Compton for training. ee

During the course of. the negotiations Baritina re-

quested higher. commissions and discounts. At'the per-

sonal conference between representatives of petitioner.

and of Baritina, petitioner’s representatives received the

impression that the representative of . Baritina had

authority. to agree to.a contract on behalf of Baritina

and..at the conclusion of the conference were under

“

ee a

the i impression that an agreement had been vaigia be-

tween the two companies regarding the provisions of a |

new- contract. In accordance with this understanding |

. petitioner’s president, under date of March 10, 1958,

- submitted to the general manager of Baritiha a proposed

new contract to be entered inté between the two com-

_ panies as of April 1, 1959, which proposed contract he

‘understood to be in accordance with the agreement:

reached at the Lpliaies “road The proposed agree-

ment submitted by petitioner’s. president to Baritina

_ with a letter dated March 10, 1958, was for a period of -

1 year and contained, among its Provisions, the fol-

lowing:

‘3. ~ Baritihe agrees ws *.

x KK KOK we

(e) Maintain at its own expense an adequate and

competent staff of “sales engineers” in ‘connection

with the selling and servicing of Oil Base’s prod-

- ucts, it being agreed that -service by trained and

skilled personnel is necessary to the proper use by.

the consumer of Oil Base’s products and to the.

proper sales coverage thereof. | |

te, In connection with the foregoing, Baritina agrees

"to send four or ‘more persons to Oil. Base’s plant

at Compton,_ California, within a period of one

hundred twenty (120) days from date hereof for

instru¢tion in the use, and sales procedures adopted

by‘ Oil Base in connection with the consujner use

es sale of its products, to wit: For instruction as

a “séles engineer” as said term js herein used. All

.- transportation, living, maintenance, and salary ex-

penses of and for such persons ‘shall be borne

and paid by. Baritina ; alae however, that Bari-

eae ane

tina may at its option in lieu of sending the afore-

described four persons for training at Oil Base’s

.plant at Compton, California, as sales engineers, .

request Oil Base to send one of its trained sales

‘engineers to Venezuela to train and. instruct:

_‘said four persons as sales engineers, all expenses of

said representative, including salary, to be borne

and paid by Baritina. The request ‘and sending of

said representative as last described: shall con-

stitute full performance’ of this Subparagraph (e)

by. Baritina. | |

¢'*:-% ‘a @

9. Baritina: agrees to maintain at all times dur-#

‘ing the existence of this agreement a minimum

stock of Oil Base material in the following quanti-

ties at the listed points or warehousing’ sites, to

wit: ct » -

ke * *

* * * Having this in mind, Baritina agrees that

the aforedescribed inventory shall never at any. “

tinf@during the term of this Agreement or exten-

-sion hereof be allowed to go below and remain

below a minimuriy purchase price value of” $100,-

_ 000.00, * * * |

10. It is ccna that Baritina has made

certain sales of all Oil-Base’s products in Colombia ;

and Venezuela.during the months of October, 1957,.

through March, 1958 during which’ times Baritina

had no sales representation agreement: with Oil

Base and no agreement with respect to payment by-

Oil Base of any commissions. to Baritina on ac-

count of -said sales, it being. further-agreed that .

calculated amounts .of said ‘commissions exceeds

alte

- $18, 000.00. In consideration of Oi Base” paying

said described commissions in such exact ‘amount

as. the same may appear and be, Baritina agrees:

to immediately erect at its’ sole expense a premix .

plant in accord with bluprints [sic] furnished to

Baritina by Oil Base. Said premix plant shall be.

erected at Las Morochas, Venezuela, for use in. the

processing, storage and sale of Oil’ Base products.

Payment of ‘said described commissions shall be —

made when said plant is erected and in operation.

he ee

14. Baritina agrees that it will maintain two

trained sales engineers” ( trained, as provided in

paragraph 3(e) -) resident in the Republic of Co-

. lombia at all times during the existence of this

Agreement, “ * >» ©

The ‘commissions and discounts set forth’ in the pro-

posed agreement were identical to those whiclt had been

contained in the prior agreement between petitioner and

Baritina: The term of 1 year in the’ contract was in

_- aecordance with information that the assistant general

~manager of Baritina had given to representatives of

petitioner ‘subsequent ‘to the personal, conferencé be- |

tween representatives of the two companies to the ef-

fect that the general manager, of Baroid Salés Divi-

sion of National Lead Company. would agreed to a 1-

year term only for the contract.”.

.. Subsequent to the submission of the proposed con-

‘tract to ‘Baritina ‘by letter dated March 10, 1958, fur-

ther correspondence took place between representatives

| of petitioner and representatives of Baritina in which

the representatives of Baritina stated that Baritina could

not agree to the new provision of the proposed con-

"je °

tract which required’ Baritina ‘to keep a minirhum in-—

ventory and to construct a premix plant in Venezuela.

The estimated cost of construction of the premix plant

was approximately $25,000.

Ina letter dated March 17, 1958, from the assistant

general manager of Baritina to ‘petitioner’s president

discussing the proposed new contract, the followitg

statement was made:

We are more than willing to continite on the

basis of. the old contract, making whatever new ar-

rangements within reason which you feel are nec-

essary in C olumbia [sic]. This would mean put- ©

a Mixing Plant or maintaining. minimum invento-

ries at the present time.

May we hope that you can see your way clear

to extend the old contract or a modified form of

the new contract: excluding those portions coms

mented on in thepreceding paragraphs,

At the time the negotiations were being carried: on

with respect to a new contract between petitioner and

Baritina, the latter company was maintaining in Ven-

ezuela’ an inventory of petitioner’s products in an

amount of approximately $85.000. |

The proposed new contract between petitioner and

Baritina was never executed and negotiations were

terminated ime April of 1958. -

* After termination of negotiations between petitioner

and Baritina regarding the new contract, petitioner’s

management gave consideration. to the best method of

ease aN

marketing petitioner’s . products in foreign countries.

After consulting counsel-in Los Angeles, California and

a Venezuelan attorney, petitioner’s board of directors

decided to form a wholly owned Venezuelan corpora-

tion to act as petitioner’s sales representative in for-

eign countries. On or about July 13, 1958, petitioner;

caused the formation of | Oil Base de Venezuela, C.A.¢

a Venezuelan corporation (hereinafter referred to as"

-Oil Base, Venezuela) as a wholly owned subsidiary of

petitioner. ‘Oil Base, Venezuela was organized with ‘a

paid-i -in capital of $6,000 and at no time during the |

fiscal year ended September 30, 1959, was this paid-

in capital increased. On or about June 20, 1958, _peti- |

tioner and Oil Base, Venezuela, executed an agreement

pursuant to which Oil Base, Venezuela, “was to act as”

petitioner’s exclusive sales representative for the sale

of petitioner’s products in all countries of the world-ex-

cept all of the States of the United States and all of

the Provinces and Dominions of, Canada. Section 8 of

this agreement provided as follows ::

8.-O.B.I. agrees to pay O.B. Ven., as Commis-

sions upon merchandise shipped divecthy by. O.Bi4.

from any of its plants or warehauses located in’

the United States of America to’ a customer lo-

cated within O.B. Ven.’s territory, such sum as

will represent twenty per cent (20%) the net

invoice billings of said sales, exclusivy; of, trans-

portation, packaging, insurance and taxes, of those

products of O.B.I. known as OB Wate, Filter

Presses, Additive “V”, OB Zero, MixFix, Addi-

tive “X” and. Additive “FE”; and such sum as will

represent forty per cent (40%) of the net invoice

billings of sales, exclusive of transportation, pack-

aging, insurance and taxes, of all other of O.B.12s °

products. O.B.1. does further agree-to allow O.B. °

Ven. discounts of twenty per cent (20%) from

its.established export: list price of its products, ex-

clusive of freight, taxes and special charges for —.

export crating, known as OB Wate, Filter Presses,

Additive “V”, OB Zero, MixFix, Additive “X”

and Additive “E”’; and-discounts of forty per cent

(40%) from its established list price, exclusive |

of freight, taxes and special charges for export

crating, on all other of O.B.I.’s products. If such

“* commissions are due O:B.’'Ven. because of direct

purchases made from O.B.I. by ‘ctstomers’ opera-

ting in O.B. Ven.’s territory as_aforedescribed,

such commissions shall be determined and paid on .

the 20th day of. the month next succeeding “the -

month in which — is made to 0. B.I. by such

customers.

_ The agreement between petitioner and Oil Base, Ven-.

“eauela, was -for a period commencing June 20, 1958, and

ending January 1, 1959, but this, agreement was ex-

tended for an additional year: to December 31, 1959.

_ The agreement between. petitioner and Oil Base, Yen-

ezuela, made mo requitement of a minimum inventory

‘tion of a premix plant, the training of four ‘sales en-

' gineers in petitioner’s plant, or the maintenance “of twa”

sales engineers in Colombia.

<On July. 1, (1958, Oil Base, Venezuela, entered’ into

a written agreement with M. R. Vollmer and M. L.

Cooper referred to in the agreement as “Volco”, under ,

which Volco was designated as exclusive sales repre-

_ sentative of petitioner’s products in the couniry of Co-

. ' s . oz 9 : ‘ ™ .

lombia. Under the provisions of this agreement Volco

was to receive a 10 percent commission on products

shipped directly by Oil Base, Venezuela, to customers

within the country of Colombia. This agreement obli- —

gated Volco to'maintain two trained sales engineers in

the. Republic of. Colombia at all times. ‘during the .ex-

istence of the agreement.

By assignment agreement dated November 24, 1958,

the agreement between Oil Base, Venezuela, and Volco

was assigned to Volco, Inc., a corporation of the coun-

_ try of Panama. Volco, Inc., was a ‘corporation formed

_ by M. R, Vollmer and M. L. Cooper. The assignment

was agreed to by Oil Base, Venezuela. Prior to July

1, 1958, M. R. Vollmer and M. L. Cooper were repre-

_ sentatives-of an agent of Baritina in the Republic of

Colombia and in that. capacity sold and serviced peti-

tioner’s products in Colombia.

On October 1, 1958, Oil Base, Venezuela, entered

into an agreement with Servicios Petroleros, S.A., a

Peruvian corporation (hereinafter referred to as Ser-

_Nicios), under which Servicios was designated as the ex-

“clusive sales representative of. petitioner’s products in

the coyntry of Peru. This contract provided for the

Same commissions and discounts which had. been pro.

vided for in petitioner’s contract with Baritina and in

the proposed contract of 7— 1, 1958, between peti-

tioner and Baritina.

On October 1, 1958, .Oil Base, Veit entered

into an agreement with Geng. Towle, under which

Towle was designated as the exclusive ‘sales representa-.

tive of petitioner’s products in Mexico. This contract

provided for the same commissions and discounts as —

| had he ics oe by petitioner to Baritina and as set

| Oe ae

3 forth i in the Proposed contract of ‘Koei 4. — be-. * >!

tween petitioner and Baritina.

| The contracts between Oil Base, Venezuela and its.

three subagents were each signed by the president of

' Oil Base, Venezuela, who was also -petitioner’s, presi-

The agreement between Oil Base, Venezuela, and

Volco, Inc., covering the period beginning July 1, 1959

and ending September 30, 1960, provided for commis-

sions to be paid and discounts fo be allowed to Volco, |

‘ Inc., in the-same amourtts as had been ‘allowed by peti-

tioner to Baritina and as were being allowed to Ser-

vicios and Gene L. Towle. |

On October 1, 1958, petitioner and Milwhite Mud -

Sales Co., Ltd. (hereinafter referred to as Milwhite),

entered into a contract r which Milwhite was des-

ignated as the exclusiv@¥sale representative for peti-

tioner’s products in the Provinces of Alberta and Sas-,

katchewan, Canada. The commissions and discounts

allowed to Milwhite under this contract werg exactly

the same as those which had been allowed by petitioner _

to Baritina and which were set forth in the proposed

contract of April 1, 1958, between petitioner and Bari-

tina. Petitioner’s agreement with Milwhite was for a

l-year period and ‘was extended for an additional pe- -

riod to October 1, 1960.

During the period beginning June 20, 1958, and con-

tinuing until about December 20, 1958, Richard New-_

man was the only full-time employee of Oil Base, Ven-

ezuela. Newman was stationed in Puerto La Cruz, Ven-

-ezuela. Prior to being employed by Oil Base, Venezuela,

N n had been employed as a sales rlineer by Bari-

tina in Venezucts and in that — a) had sold and.

-. —2]l—

serviced petitioner’s products. Prior to becoming em-

ployed by Baritina, Newman. had beer employed as a-

sales engineer for petitioner. Newman severed his con-

‘nections with ‘Oil Base, Venezuela about December y

_1958.°A period of approximately 2 weeks expired be-

fore Newman’s replacement arriyed in Puerto La Cruz,

Venezuela. oe ae a

Newman’s replacement was a man named White who

- had been employed by petitioner prior to becoming ‘em-

ployed by Oil Base, Venezuela. White took over his du-

ties with Oil Base, Venezuela, shortly after January 1,

‘1959. White was the only fuil-time employee of Oil

Base, Venezuela, from the time he -became so employed

throughout the balance of the fiscal year ended Septem-.

ber 30, 1959. Newman while employed by Oil Base,

Venezuela,,,and White when. he replaced Newman,

served as sales engineer, service engineer, and: general

manager of Oil Base, Venezuela. |

Shortly after Oil. Basey

public accountant located in

open a set of boaks for the newly organized corporation

and it was agreed that -this accountant would be paid for

_ bookkeeping service for the corporation and in addition,

with no additional charge, he would permit Oil Base,

Venezuela, to use his post office box number in Puerto

La Cruz and furnish an office for the general manager

of Oil Base, Venezuela, to occupy: from time to time.

This accountant had other clients besides Oil Base, Ven-

ezutela. It was agreed that: the ‘payment for services,

enezuela, was organized, a

__ without any additional charge for the use of the post of-

ficé box and furnishing an office, would be approxi-

mately $150 per month: The accounting practice of the —

accountant with whom Oil Base, Venezuela, made. the:

enezuela was paid $75 to. -

~ DB,

eth a.

arrangement was purchased around the first of May -

1959 by an accounting firm which continued the same

arrangement with Oil Base, Venezuela. 3

During the fiscal year ended September +30, 1959, the

president and vice president of petitioner, who were also

the president and executive vice president .of Oil Base,

Venezuela,-made a trip, to Venezuelayyand during the

course of the trip visited Mexico and Colombia. Most of

the time the two, officers of petitioner and Oil. Base,

Venezuela, were traveling together. In the business deal-

ings conducted in Venezuela, they represented them-

selves as officers of Oil Base, Venezuela. During some

of the trip, the two officers were accompained by New-

man, the manager of Oil Base, Venezuela. On‘the trip

in Colombia, petitioner’s two officers were accompanied

- by the Colombian agents who handled petitioner’s -prod- |

ucts and represented themselves. as officers of Oil Base,

Venezuela. In accordance ‘with the agreement between

Oil Base, Venezuela,”and: petitioner, each of the com-

panies bore one-half of the expense of ‘the trip made by

these officers to Venezuela, Colombia, and Mexico.

{t had been petitioner’s consistent practice during the

years that it was marketing its products in: foreign coun-

tries to send its employees to the countries‘ th which its

products were being sold for the purpose of assisting

- its sales representatives arid servicing the use. of its.

products. Petitioner’s assistant sales manager was us-.

ually the representative sent to Venezuela and @olgmbia,

and while on such trips he actually went to the site

where petitioner’s products were being used and serv-

iced the iise- of petitioner’s products. The expense of

these trips was borne solely by petitioner. ss

= ie

As of September 30, 1958, Oil Base, Venezuéla,- had

_ inventory of a valué-of $21,809 stored at a leased ware-

house at Puerto La Cruz, Venezuela; and as of Sep-

tember 30, 1959, it had inventory stored at this ware-

house of a value of $27,764. As of these same’ dates

Oil Base, Venezuela, owned office equipment which had

a cost of $758 and’ an automobile which had a cost of

$3,611; and as of September 30, 1959, Oil Base, Ven-

ezuela, owned furniture for a —— s house which

-. had a cost of $1,200. .* +: oe :

- During the fiscal ‘period ended September 30, 1958,

and the fiscal year ended September 30, 1959, Oil Base,

Venezuela, leased a warehousé in Puerto’La Cruz for

Bs.500 per month. Dufing the fiscal year 1959 it re: |

ired three and one-third bolivars (Bs.) to equal one

United States: dollar’: | F

- During the fiscal period ended - Septiatber 30,. 1958,

and the fiscal year ended September 30, 1959, Oil Base,

‘Venezuela, leased a manager’s house located at Phillips

Camp at San Roque, Venezuela, for a monthly rental of

BS.800 and a house located at Nalco Camp, Anaco, for

a monthly rental of Bs. 1 ,000.

For the. fiscal year ended September 30; 1959, Oil

Base, Venezuela, was charged for services rendered, ’-

a: ,136.33 and $1,055.33 of the salaries paid by peti-

oner to its. president and vice president, respectively,

who were also the president and executive vice president

of Oil Base, Venezuela. In addition petitioner’s treas-

*. urer also rendered.services for Oil Base, Venezuela, and

for such services rendered by the individual, who was

petitioner’s treasurer until July 1959, Oil Base, Venezu-

" ela, was charged $275.40 and for services rendered by

_ the individual who became petitioner’s treasurer on July

ill

“1, 1959, Oil Base, Venezuela, was charged $117.63 for.

services rendered during the fiscal year ended Septem- ;

‘ber 30, 1959.:: a

' Oil Base, Vewids, had net income ‘eit retained ai

earnings of $18,208 for the 314 month period ended Sep- \

tember 30, 198. and a net income of $81,031 for its|

fiscal year ended September 30, 1959, and retained earn- -.

_ ings of $99,259 for the fiscal year ended September 30,

1959. Petitioner’s direct’ profit from sales for. its. fiscal :

"years ending, September 30; 1956, 1957, 1958, and 1959,

expressed as-a percentage of total gross‘sales, the similar

direct profit for domestic sales expressed as a percentage

of those sales, and export sales expressed as a Piermnee

of such sales are as follows:

Fiscal years ‘ended i 30 —

1957, - 1958 1939.

Percent

Total. = 247 2116 1 8O-.. . ae

‘Domestic 224 (140 212 ~- 22.5.

Export - 34.6 .301 456. — 23.9

_ Direct profit used in computing these percentages rep-

resents the profit after deducting from gross sales all -

discounts and commissions allowed, njanufacturing costs

_ ing salesmen’s: taints salaries, and entertainment ex-

a penses 5. ; : : :

Throughout the fiscal year ended September 30, 1959,

petitioner owned all of, the outstanding capital steck-of _

Oil. Base, Venezuela. ae oe “Ye

‘Each of the officers ‘ins directors of Oil Base, Ven-*

ezuela, was also an of ficer of petitioner. Crores

_ ployees of petitioner.

“2

: om

_ In May ot 1958, prior to the ¢ organization of Oil Base, :

Venezuela, petitioner’s vice president made a trip to’ e,

Venezuela and Colombia, at which? time ‘he : discussed

_ with Newman, who was then employed by Baritina, em- _

» ployment ‘in Venezuela by petitioner’s proposed subsid- |

iary. He also discussed: with Vollmer.and Cooper in. Co-

lombia ° their serving as sales” representatives . for peti-

_ tioner’s products in Colombia: At that time Vollmer and

Cooper ‘were. employees of ‘the ‘subagent who was the

distributor of petitioner’s Products in Colombia on be-

* half of. Baritina.

Certain officers at petitioner who were also officers

of Oil Base, Venezuela, carried on extensive cotrespond- :

ence on Wehalé of Oil Base, Venezuela, from petitioner’s

offices in Compton, California. Although the letterhead

:0f Oil Base, Venezuela,. was “used for. this correspond-

ence, such correspondence was po raps tage in Comp-

ton, California by - secretaries who were full-time em-

\ @ During the fiscal year ended September 30, 959, ‘be-

tween 80 and 85 percent of the sales of petitioner’s prod-

ucts ir the Republic of Colombia were madegto Texas

‘Petroleum Company i in Colombia. Some of the sales: re-

sulted from orders sent by. Texas Petroleum Company’s -

‘New’ York: City office to petitioner in Compton, Cali-

‘fornia with directions: that the order was td be Shipped

to Texas Petroleum Company in Colombi Petitioner .

would then prepare documents showing petitioner as the

shipper and Texas Petroleum Campany, Colombian Di-

vision, as the consignee and purchaser. ee’

‘P&titioner on its Federal income tax return for “its

fiscal year ended’ September 30, 1959, reported, taxable _

income of - An? 80.

“ F . . i

. 6 oO:

—

Respondent if in his notice of deficiency, in addition to |

~ making-adjusthents which, though originally placed in

issue in the petition-in_ this case, have now been a a

of by agreement of the parties, increased petitioner’s

' “reported irjfeme by an amount of $106,699.14 designated -

as “Sales increased” and made the _—— explanation _

- of this adjustment :

It is determined that. commissiqns paid and dis-

counts allowed té your controlled foreign subsid- -

jary, Oil Base de Venezuela, C. A. were excessive

in amount and had the effect of improperly shift- ‘

ing income from you to your Controlled foreign _

subsidiary, thereby distérting your income and the

. income of your subsidiary. Furthermore, sales com-.

. missions were paid to Oil Base de Venezuela on cer-

tain sales occurring outside of Venezuela which

were, in substance, your sales“and on these sales no

commissions are being allowed under this determi-

nation. In determining the proper amount allow-

able as commissions ‘and discounts paid to Oil Base

de Venezuela, C.A. where some amount is properly

allowable, the determination has been based on

". arim’s length negotiated rates between yourselves

and uncontrolled. parties on identical goods and

services. This issue. involves the application of set-.,

tions 61 and 482 of the Eternal Revenue Code of

1954. * * *

Pr ee re Oeics Sew

‘ox

OPINION.

Petitioner recognizes that it’ and Oil Base, Venezuela,

are organizations owned and controlled ‘by the same in- -

terests within the meaning of section 482 of the In-

ternal Revenue Code of 1954.' Petitioner contends’ that’

under. that section respondent ha$ erroneously used, in

‘the reallocation of gross income deductions, credits, or |

allowances between petitioner and its subsidiary, a stand-

. ard of arm’s length bargaining. Petitioner points out*

that no such. provision is contained in the statute and

that —_—— respondent’s regulations’ contain | a state-

1Air referenves are to the Internal Revenue Code of 1954 7

. unless otherwise indicated. ;

SEC. 482; ALLOCATION _OF INCOME AND DEDUC- ‘

| TIONS AMONG TAXPAYERS: ;

In any case of two or more organizations, trades, or businesses

(whether or not incorporated,whether or not organized in: the .

United States, and whether or not affiliated) owned or coz-

trolled directly or indirectly by the same interests, the Secretary

or his delegate may distribute, apportion, or allocate gross in-

come, deductions, credits, or allowances, between or among such

organizations, trades, or businesses, if he determines that such

distribution, apportionment, or allocation is necessary.in order -

to prevent evasion of taxes or clearly to reflect the income of

any of such organizations, trades, or businesses. -

Sec. 1.482-1(b) [Income Tax Regs.] Scope and purpose. . -(1)

. The purpose of section 482 is to place a controlled taxpayer

on a tax parity with an uncontrolled taxpayer, by determining,

according to the standard of an uncontrolled taxpayer, the true ~

taxable income from the property and business-of a controlled

taxpayer. The interests controlling a group 6f controlled tax-

payers are assumed to have complete power to cause each con-

trolled taxpayer so to confluct its affairs, that’ its transactions: .

and .accounting records truly reflect: the taxable income: from

+ property and business of each of the controlled taxpayers.

If, however, this has not been. done, and the. taxable incomes

are thereby understated, the district’ director shall intervene, and,

by making suclr distributions, apportionments, or allocations as -

, he may deem necessary of gross income; deductions, credits, or

allowances, or of any item or element affecting taxable income,

(This footnote is continued on the next page)

ae]

has been applied.by” the, courts. |

Sa”

_-ment that’ the standard to be applied in every case is.

that of an uncontrolled taxpayer dealing at arm’s length ,

with another uncontrolled taxpayer, no such standard

. Petitioner relies primarily upon Frank v. Interna-

: tional: Canadian Corporation, 308 F. 24 520 (C.A. 9;

1962), and cases cited and discussed i in that case.

_ Petitioner ‘relies particularly on the following para-

wrath in Frank’ v. International Canadian C orporation, :

supra: i .

_. For example, it was not any iene proper for the

- district court to tise here the “reasonable return”

standard than it was-for other courts to use “full .

- fair value,’® “fair price, including a . reasonable

~ profit,” “method which seems not -unteason- .

able,” “fair consideration which reflects arm’s _

length dealing,” “fair and reasonable,”” “fair

‘ and reasonable” or “fair and fairly arrived at,”

or “judged as to fairness,” [footnote omitted] all

used in interpreting: § 45 [of the Internal Revenue

Code of 1939, the predecessor of Sec. 482]. _

ae ae

8The Friedlander Corp., 1955,,25 T.C. 70, 77.

es ye yee ng Inc., 1951, 17 T.C, 231, 260, affirmed

S Cir.. 2d 873, certiorari denied, 346 USS. 819,

74S. Ct. an, BL Ed. 348. :

Motor Securities Co., Inc., 1952, 11 TCM 1074, 1082.

11Pqlm Beach Aero Corp., 1952, 17. T.C. 1169, 1176.

‘ 12Polak’s Frutal Works, Inc., supra i Th. la (1954) ]

21 T.C. at 975-976.

8 Seminole Flavor Co:, 1945, a ye oe i215, 1232.

between or among the controlled taxpayers constititing the group,

shall determiné’the true taxable income of each controlled tax-.

payer. The standard to be apptied in every case is that of an °

uncontrolled taxpayer dealing at arm’s length with another un-

. ‘controlled taxpayer.

—m,: ¢

It is petitioner’s position that since it retained a slightly

higher percentage of, direct profit. from: export marae

than from domestic sales even after allowance of com-

missions and discounts_toits subsidiary in accoréance

with their gontract, it has established, under the criteria \

of Frank v. International Canadian C orpgration, supra,

that it retained a reasonable return.

It is “unnecessary for us to decide whether the sole

standard in cases under section 482 is.one of an amount

which would be arrived at in arm’s length -transac-

tions betweert-unrelated parties. The commissioner has

been given much latitude in his use of section 482 when

,» “necessary to prevent the evasion of Federal income tax

by shifting of profits between taxpayers subject to com-

mon control. Ballentine Motor Col, 39 T:C. 348, 357

(1962), affd. 321 F. 2d 796 (C.A. \ 1963). ~~ °

The burden is on. petitioner.to Show error in re-

spondent’s allo¢ation, and respondent’s determination

must be ‘sustained unless it is unreasonable, arbitrary,

_or-capricious. Grenada Industries, Inc., ‘17 T.C.-231,

255 (1951), affd. 202 F. 2d 873 (C.A. 5,. 1953),

.certiorari denied 346 U.S. 819. There is no evidence to -

show that the percentage return retained by petitioner

on domestic sales would represent a reasonable return

_ on its export sales. There is‘ likewise no evidence to show...

‘that the amount of commissions and discqunts paid t9 ~\

Oil Base, Venezuela, represented a reasonable amount, a __

fair amount, or an amount which would meet any of

the other criteria referred to by the Court in Frank v.

‘International Canadian Corporation, supra. Certainly

the fact that these commissions are almost double those

paid by petitioner to unrelated persons in arm’s length -

transactions is evidence that they were -not fair and

reasonable. - '

Petitioner. justifies the rates established for Oil Base,

-been paying to Baritina and was currently paying to its

representative in’ Canada, as well as about twice the

amounts which its: distributors, through classed as sub-

3 agents of Oil Base, Venezuela, were charging in- other. .

| countries, by stating that petitioner ’s hoard” of directors

considered a number of factors in arriving ‘at the rates

of commission and discount. The factors which peti-

tioner stated were’ considered were that Baritina had

represented to petitioner that it, had just about been

breaking even with respect to its representation of peti- |

tioner; that Oil Base, Venezuela, would be handling —

only petitioner’ s products ‘whereas Baritina had handled .

and consequently had a broader base over which to

spread its overhead costs; that Oil Base, Venezuela,

would be starting from. the. very beginning whereas ~

Baritina was an. established and’ going. concern; the |

manufacturing costs of the products involved which, of - “cline

course, were known to petitioner as well as the selling

price of the products;the high cost of’ operating in

Venezuela and Colombia which was known to petition--

- ef’s management; and that: it. would be necessary for

Oil Base, Venezuela, to obtain subagents and distribu-

tors. in various foreign countries and: to pay them com-

missions on sales made in those countries."

None of the alleged reasons justifies. the rate of com-

missions and discounts allowed to Oil Base, Venezuela.

Petitioner, irt its proposed contract with .Baritina had

not increased-the rate of commissions and discounts

although it was insisting on minimum inventory to be

maintained by Baritina, the building of a premix plant,”

and the training of several sales engineers. It would, |

therefore, appear. that, if personnel of Baritina_ had

--Tepfesented to petitioner that, Baritina had just about

been breaking. even with respect to representation of

petitioner, petitioner: was not impressed with this repre-

sentation to the extent that it was ‘considering: the rais-

ing of commissions for Baritina or withdrawing fram |

some of the additional demands it, was maeeing upon

Baritina.

‘The second contention is likewise unimpressive. Oil

» Base, Venezuela, had only:one full-time employee, who

was the same person who as an employee of Baritina had

devoted full time to petitioner’s products. This arrange-

ment was made prior, to the. incorpération of .Oil Base,

Venezuela. Petitioner does ‘ not explain why it consid-

ered a concern that was merely beginning in. business.

to be entitled to a higher commission than a going con- -

cern with a number of employees. Petitioner has shown |

no reason why its knowledge ofthe gross profits from

its sales should persuade it to allow commissions to its

subsidiary about twice those it had previously paid,

other than the inference that respondent would draw’ of

‘shifting i income to Oil Base, Venezuela. The high opér-

ating costs in Venezuela would not affect: Oil Base,

Venezuela, to an’ appreciable extent since its: manner

—of-operation had been set prior to its incorporation.

Petitioner’s last point is not well taken since it has -

«not shown why Oil Base, Venezuela,. should. have, any,

“appreciable profit on sales. made by subagents in other

ae _ foreign countries. All of the evidence of record jn this

_ "case indicates that a fair and reasonable commissiori

: and ‘discount to be allowed to Oil Base, ‘Venezuela is

the. amount of commission and discount that had been

; "3 é .

ys ae —32— :

_ allowed to. Baritina, was proposed in the new contract to

‘be allowed’ to Baritina, and was allowed to petitioner’s

Canadian representative and various’ subagents with the

exception of a lower commission being allowed to the

a Colombian representative for’a short period’ of time.

See Jesse E. Hall, Sr.; 32 T.C: 390 (1959), affd. 294

F. 2d 82 (C:A. 5, 1961). We sustain respondent: with

respect to ‘his determination of the amount of commis-_

sion. properly. allowable on sales in Venezuela. ae

The evidence ‘clearly shows that petitioner fieeded

sales representatives in Colombia-and Mexico and that

some commissions or. discounts were necessary: ‘ge obtain

—such representatives. Respondent’s action .in disallowing

_* commissions and discounts on such sales is Unrea-

sonable and arbitrary. ‘During the time’ Baritina repre-

- sented petitioner, that company handled petitioner's sales

in Golombia through a: subagent at the same commis-

7 sions and discounts paid to it for, sales in Venezuela. o

Petitioner has failed to show why commissions and dis-

counts on sales in Colombia, Mexico, and Peru, if any,

paid to Oil Base, Venezuela, should be different from

'. those allowed to Oil Base, Venezuela, on salesin Vene-

zuela. “The agreements with thé various subagents were

for’amounts of discounts and commissions identical to

those paid by petitioner to Barjtina and to its Canadian .

_ representative, and which respondent recognizes: as

' proper to be allowed to Oil Base, Venezuela, on sales

in Venezuela, except for a short period .of the contract

with Volco in Colombia. However, petitioner - has

_showri no services “performed by Oil Base, Venezuela,

which would entitle it to a profit on these Sales.

‘In this state of the record, we tonclude that the same

rates of commissions’ and discounts which respondent:

“TSP. ®

Sew eee eee foe

BT EN arg cid Ay at an RS

Ae Gal acta te ~

ae 8

9°

es tes allowed to petitions? in pee its deductions

with respect to sales in Venezuela. are allowable to de-

termine the proper deduction by. pétitioner with respect.

to sales in Colombia, Mexico, and Peru. We therefore

hold that the tates of, commissions allowed by respond-

ent with respect to petitioner’ s Venezuelan sales are also

proper with respect to all sales’ of petitioner’ s products

in Colombia, Mexico; and Peru made through Oil Base,

Veneziiela, ‘during the fiscal yaar ended September 30,

1959, ‘in computing the aniount of the commissions

paid by petitioner to its subsidiary which is properly

‘deductible by petitioner in determining its taxa in-

come for its fiscal year 1959.*

eek "Decision will be entered under Rule 50.

, ¢,.

8Joint ‘Exhibits 26-P and 1 270, stipulated exhibits. incorpo-

rated herein by teference, show the necessary information from

| which this: ee may be —:

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.