Memorandum in Opposition — Oil Base, Inc. v. Commissioner

: an he Sugreme ou of te ited States |

Ocrosm TERM, 1966.

No. 466. -

ao

Om Bass, INc., PETITIONER

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COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF OBRTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE nana O1nOUIT

MEMORANDUM FOR a RESPONDENT IN OPPOSITION

' This case involves the scope of the Commissioner’s

statutory power under’ 1954 Code § 482 to reallocate.

incomé between entities. which are under common |

control. We have set, forth § 482 and the most per-.

tinent portion of the Regulations thereunder: in the

Appendix. . j

Petitioner ‘nmnedinienien and sells oil base drijling ©

- fluid and related products to the oil.drilling industry.

Prior to June, 1958, petitioner made its foreign sales .

through various independent sales representatives.

_ At that: time it created a new Venezuelan subsidiary

and executed a contract making the subsidiary its: ex-

elusive foreign sales representative (except for .Can-’

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2831-44466 ~ .

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ada) at a stated rate of ‘discounts and commissions

“approximately double those paid to its previous inde-

pendent, sales representatives. Petitioner’s Vene-

zuelan subsidiary had one full-time employee and a

_ capital of $6,000. For its fiscal year ended Septem- '

_ ber 30, 1959 (the period here in question), the Vene-

zuelan subsidiary had net earnings of $81,000, while

petitioner’s net income for the same period. was

$20,457. (Pet. App. 2-33)..

7 The Commissioner, acting under § 482 of the In- -

_ ternal Revenue Code of 1954, rejected the stated ¢om-

missions and discounts as not clearly reflecting the

income of the parties. and as having thé'effect of im-

properly shifting income from petitioner to its con-—

trolled foreign subsidiary. Pursuant to Treas. Reg.

§ 1.482-1(b) (1), the -Commissioner | allocated to peti-

tioner that income which arm’s-length arrangements

with uncontrolled foreign sales representatives: would

~ have producéd: The Tax Court and_the,court:of ap-

‘ peals upheld the Commissioner’ s determination (Pet.

App. 2-6).

The decisions of the. lower courts, which : are pri-

marily factual 3 in nature, are supported by the record

and are clearly correct. ‘There is no confliet among |

the circuits or other reason for further review. :

1, The purpose of § 482 is to prevent a taxpayer

from arbitrarily shifting part of its income. to an-

other related taxable-entity by’ such devices ds ex-

_ cessive commissions, discounts, fees, ete. The Com-

_ missioner’s authority. to reallocate income between

. , related corporations extends to any ease in which,

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either by inadvertence or design, the taxable net in- .

~ come is different than it would have been had the eon —

- porations dealt with each other at arm’s length: Com-

missioner v. Chelsea Products, 197 F. 2d 620 (C.A.

3); -Atken Drive-In Theatre Corp. v. United States, -

- 281 F. 2d 7 (C.A. 4); Spicer Theatre, Inc. v. Com- —

missioner, 346 F'. 2d 704:(C.A. 6); Simon J. Murphy

Co. v. Commissioner, 231 F. 2d 639 (C.A.6). = *

‘Section 482 vests the Commissioner with broad, dis-

cretion, and lis determinations under that provision

should be overturned only if shown to have been

arbitrary or unreasonable. Helvering v. Taylor, 293

U.S. 507; G.U.R. Co. v. Commissioner, 117 F. 2d 187:

(C.A: 7); Ballentine Motor Co. v. Commissioner, 321

F. 2d 796 (C.A. 4) ; Campbell County State Bank, Inc.

of Herreid, S.D, v. Commissioner, 311 F. 2d 374 (C.A.

8); Spicer Theatre, Inc. v. Commissioner, supra; ——-

National Securities Corp v. Commissioner, 137 F. 2d.

600 (C.A. 3), certiorari denied, 320 U.S. 794; Grenada

Industries v. Commissioner, 202 F.2d 873.(C.A. 5),

certiorari denied, 346 U.S. 819. The record in the

instant case adequately supports the lower courts’

conclusion ‘that the Commissioner did not abuse his

discretion or act unreasonably in invoking and ap-

plying § 482. , oe :

, 2. Petitioner argues that certain factors bearing on —

ite Venezuelan ‘subsidiairy’s business activities justi-

fied its action in granting the subsidiary commissions

and discounts which were double those given its -

previous ‘independent sales representatives. The

lower courts fully considered these factors and re-

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jected them as ; unsupported by the = sofaan App.

30-31, 6).?

3. Petitioner argues . ‘that the Ninth Circuits

opinion in Frank v. International Canadian Corp.,

308 F. 2d 520, has created uncertainty as to the stand- |

ard to be applied under § 482 in testing transactions

between rela orporations. As that opinion makes

clear, the court’s limited departure from the arm’s-

“"1 For example, although petitioner claims that its former

principal sales representative, Baritina, was seeking larger

commissions and discounts (Pet. 5), the record shows that -

shortly before petitioner forméd its*new subsidiary, Baritina .

nad expressed willingness to continue at the old rate of com-

pensation (I.R. 32-85; Pet. App. 12, 15).* (R. references are |

to the reproduced record filed in the court of appeals.) More-

over, petitioner’s president testified that if Baritina sold peti-

tioner’s products properly, it could make an adequate, profit at

the existing rate of commissions, and discounts (II-R 48).

Finally, the record shows that. petitioner’ s contract with an. f

independent Canadian representative and its Venezuelan sub- |

sidiary’s contracts with. three independent subagents—all made

subsequent to petitioner’s contract with the subsidiary—speci-

fied approximately the. same rate of compensation as had been |

paid under the old Baritina contract, <.e., approximately one-

half the amount petitioner — its Venezuelan subsidiary (Pet,

App. 19-20, 2).

Petitioner argues that in two tax years subsequetit to the

period here in question its Venezuelan subsidiary suffered losses

totalling $4,000 (Pet. 9). Petitioner is apparently attempting

to use these figures to show that -the compensation received’ by

the subsidiary was not excessive. However, since the alleged

loss years (1961 and 1962) were not involved in this case

(which concerned only 1959), no effort was made at trial to_

substantiate the figures, and, in fact, petitioner refused to pro-

duce ‘its Venezuelan subsidiary’ s books and records for these

years. Nor, assuming that the subsidiary did suffer small

losses in 1961 and 1962, was any effort made to ascertain

whether they were due to some external factor, such as political

turmoil i in Venezuela. .

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: | SEPTEMBER, 1966.

aes a

length standard was based upon an inartfully: worded

stipulation which the court “might well {have used

» to} find that the Commissioner stipulated himself

_ out of court of thig issue” (p. 528), and on the failuré. -

of the. record to support the commissioner’s determni-

nation on mark-up (p. 529). In any event, in decid-

ing ‘the ‘instant case, . the N inth Cireuit—the same

court that decided I nternational Canadian Corp. —ac-

cepted the arm’s-length _standard contained in the -

§ 482 Regulations ‘and stated that its prior decision in

- s International Canadian Corp. was, ee speik ited

limited’’ (Pet. App. 5).

For the foregoing reasons, the petition for a writ

: of. certiorari should be denied. |

Respectfully submitted, 7 fry.

i ~ TruRGoop MARSHALL,

— Solicitor General.

MrroHEnt Roaovin,

Assistant Attorney General.

Davi O: WaLTER,

STEPHEN H. PAtey, .

Attorneys.

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APPENDIX

Internal Revenue Code of 1954:

Sec, 482. ALLOCATION OF INCOME AND DEDUC- | .

TIONS AMONG TAXPAYERS.

In any case of two or more organizations,

trades, or businesses (whether or not incorpo--

rated, ’ whether or not organized in the United

States, and whether or not affiliated) owned or

controlled -directly or indirectly. by the same

’. interests, the Secretary or his delegate may

distribute, apportion, or allocate gross income, |

deductions, credits, or allowances hetween or

_ among such organizations, trades, or businesses,

if he, determines that such distribution, appor-

_tionmient, or allocation is necessary in order tu.

prevent evasion of taxes or clearly to reflect the

income of any such organizations, = or

businesses.

| (26 U.S.C. 1964 ed., See. 482.) |

‘Treasury Regulations'on Income Tax (1954 Code) :

SEC. 1.482-1. Determination of the taxable in-

| come of a controlled taxpayer.

* ~~ @. @.‘> * %

(b) 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 pro Sapa d and business of a controlled .

' taxpayer. interests controlling a, group of

controlled taxpayers are assumed to have com-.

plete power to cause each controlled taxpayer

3 $0 to conduct its affairs. that its ‘transactions

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-and accounting records truly reflect the taxable

income from the property and business-of each .

of the controlled taxpayers. If however, this

has not been done, and the taxable income: are

hereby understated, the district director shall

intervene, and, by. making such 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, between or among the controlled |

taxpayers constituting the group, shall deter-—

mine the true taxable income of each controlled .

taxpayer. The standard to be applied in every

case is that of an uncontrolled taxpayer dealing

-at arm’s length with another uncontrolled tax-

‘payer. ee : bay S

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U.8, GOVERNMENT PRINTING OFFICE:1966

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LIMWARY e es RILE

COURT: IY RHE. S| © OCT 17 1966

os

Office-Supreme Court: US.

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Supreme cour of the United Staltden

October Term 1966

‘No. 466 — .

“ame

Oiv BaAsg, INc., * . ia

| _ Petitioner,

| US. P , . 4

CoMMISSIONER OF INTERNAL REVENUE,

Respondent,

On Petition fora Writ of Certiorari- to the United States -

Court of Appeals; for the Ninth Circuit. VY

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Petitioner’s Brief in Reply to the Memorandum for

_, the Respondent in Opposition.

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+. Wirson B. Cops, io

WELLMAN P. THAYER, - |

» 900 Wilshire Boulevard,

Suite 1224,

Los Angeles, Calif. 90017,

Attorneys for Petitioner.

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

a,

‘Supreme Court of the United States

October Term 1966

No. 466

O1t Basg, INc.,

; ¢ Petitioner,

" US:

COMMISSIONER OF INTERNAL REVENUE,

Respondent,

‘On Petition for a Writ of Certiorari to the United States

Court of Appeals for the Ninth Circuit.

. es

Petitioner’s Brief in Reply to the Memorandum for

the Respondent in Opposition.

The Respondent in his Memorandum in Opposition |

in this proceeding states that with respect to the issue

involved, there is no conflict among the circuits or other

_reason for further réview. The Petitioner does not con-

tend that a conflict among the Circuits exists. However,

‘the Petitioner does contend that this case presents to

the Court an opportunity to put to an end the uncer-

tainty and confusion which éxists in the increasingly

important areas of tax law administration and inter-

national business operations. The Respondent does not

‘answer this contention. Indeed he cannot, since, as

pointed out in the Petitioner’s Petition, the uncertain-

ty and confusion in this area is well reopgnined. ( Pet.

. pp. 11- -12.)

te

The Respondent argues that the purpose of Section >

482 of the Interhal Revenue .Code is.to prevent the

arbitraty shifting of income. Petitioner continues to con- |

tend, however, that the Commissione?’s: power-to-so.allo-

cate income and deductions is not suchas to permit him

to force one of the controlled corporations to operate at .

ee

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‘aloss. The exercise of stich power to such. effect must’

constitute -an arbitrary and unreasonable exercise

thereof. ~ - .

The Respondent contends that the decisions of the

Courts below are in part supported by: the fact that

the Pétitioner’s wholly-owned foreign subsidiary had

during the taxable year in question only one full time

employee and that the Petitioner originally invested only

$6,000 in the capital of the subsidiary. While it is true

that the subsidiary had only one full time employee, it

is also true*that many services were rendered to it by -

part-time employees and by independent, contractors.

(Pet. p. 8, Pet. App. pp. 22-24.) The reason for the rel-

atively low invested capital and the reason for main-

taining only one full time employee was the decision

of the Petitioner’s management to start and proceed

cautiously in this new venture. The Petitioner had never

before operated in.a foreign country either directly or

through 2. subsidiary. That the Petitioner’s decision to |

proceed conservatively i in its approach to the operation

of a foreign ‘subsidiary was wise is well borne out by

the results of its subsidiary’ S operations in the years

succeeding the one year which was before the Courts

below in which succeeding: years the subsidiary oper-

ated at either an insignificant ey or at a loss. (Pet.

ae + So

While it is true that the em issue before the

Courts below. was the Petitjoner’s tax liability for ‘its

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fiscal year ended September 30, 1959, it is. also true

- that the underlying’ issue was whether or not the rates"

of commission: and discount which were in effect, as

between the Petitioner and its wholly-owned subsidiary} |

were such as to distort the true income of the Peti-/)

tioner, or to improperly shift: part of its income to its

wholly-owned subsidiary. While the years subsequent

to the fiscal year 1959 ‘were not before the Courts,

below, the Petitioner rievertheless contends that the

results of the subsidiary’s operations in those subse”

quent years (in which the rates of. commission and

discount remained the same) should have been c consid-

ered by the Respondent and by the Courts below in

their determination as to whether or not the commis-

sion and discount rates were excessive. The Respondent

in his footnote on page 4 of his Memorandum contends

that the figures-eoncerning the losses. in subsequent

years were not substantiated, and that such losses might

possibly have been caused by some imagined external

factors. The results of the subsidiary’s operations’ in

these subsequent years were determined by independent

Certified. Public Accountants. There was no showing

in the Courts below’that any external factors such as

political turmoil as suggested by the Respondent’ had

any appréciable effect thereon., t seems only equitable

and just that the Respondent in exercising the powér’

conferred upon him by Section 482 of the Internal

Revenue .Code should take all reasonable factors into

consideration. For the Respondent té make‘a detertnina-

tion on the basis of one year’s operations only as he °

has done in this case when in fact he had the results

of subsequent years’ operations available ‘to him, con-

stitutes an unreasonable arbitrary, and abusive exer-

cise of such power.

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_ The Respondent argues in the fobthote" in his Memo-

randum: that Petitioner’s former iy representative,

Baritina, was willing to continue urider its old contract. |

The fact remains, however, that Baritina did- refuse to

negotiate a contract with Petitioner upon terms: which

were mutually acceptable. Petitioner’s subsidiary was

required to fulfill the functions of the former represen-

tative and in addition to assume responsibilities over ‘and

above that which had been executed ‘by the former rep-

resentative. While discharging these responsibilities it

earned net income in the 1959 fiscal year, the year under

consideration. However, the record in the Courts below

also establishes the fact that by the use of the same com-

mission and discount rates and while discharging the

-. same responsibilities, subsequent years demonstrated that

the subsidiary was: tinable to earn net incomes The

conclusion is inescapable that the Commissioner abused ..

his power in fixing cgmmission and discount rates under _

which ‘the subsidiary could not function without incur-

ring operating losses. j eae

The Petitioner continues to contend that the fair.

and reasonable doctrine enunciated by the Ninth Cir-

cuit in its Opinion in Frank v. International Canadian

Corp., 308 F. 2d 520, was not by that Court narrowly

" limited to the facts before it in that case, but, on the

‘contrary, that it was expressed therein as a fundamen-

tal principle of tax. law supported by numerous Court

decisions which the Court cited in support tegen.

(Pet. pp. 16-17.) oe ‘

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ie, For the foregoing reasons and those stated in the

Petition, the Court is urged to grant the Writ of Cer-

tiorari. . |

Respectfully submitted,

Witson-B. Cores, «—

WELLMAN 'P. THAYER,

Attorneys for Petitioner.

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