DocketNumber： Docket No. 17527-88
Citation Numbers： 96 T.C. 652, 1991 U.S. Tax Ct. LEXIS 31, 96 T.C. No. 25
Judges： Nims
Filed Date： 4/16/1991
Status： Precedential
Modified Date： 10/19/2024
P, a manufacturer of computer products, utilized a domestic international sales corporation (DISC) as a commission agent for export sales of its products.
*653 OPINION
Respondent determined a deficiency in petitioner's 1981 Federal income tax in the amount of $ 385,708. The issues for decision are: (1) Whether petitioner properly apportioned and allocated the discount incurred on its transfer of accounts receivable to its domestic international sales corporation (DISC) in computing the commission payable to the DISC under full cost accounting; (2) whether petitioner properly applied the discount incurred on its transfer of accounts receivable to its DISC in computing the commission payable to the DISC under marginal cost accounting as limited by the overall profit percentage limitation; and (3) whether export promotion expenses incurred by the DISC pursuant to the terms of a written agreement between petitioner and the DISC may be included in the commission payable to the DISC.
Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the year in issue and all Rule references are to the Tax Court Rules of Practice and Procedure.
All of the facts have *33 been stipulated and are so found. The stipulation of facts and related exhibits are incorporated herein by this reference.
Computervision Corp. (petitioner) is a Delaware corporation which had its principal place of business in Bedford, Massachusetts, at the time of filing the petition herein. Petitioner, an accrual basis taxpayer using the calendar year, is in the business of designing, manufacturing, and selling computer products. For 1981, petitioner timely filed a consolidated Federal income tax return with its subsidiaries Computervision Productivity Centre, Ltd., Computervision Australia, Ltd., and Computervision (Europe), Inc.
Computervision International Corp. (International), a Massachusetts corporation, was a wholly owned subsidiary of petitioner during the year at issue. International was an accrual basis taxpayer with its taxable year ending on January 31. During its taxable years ending January 31, 1981, and January 31, 1982, International qualified as a domestic international sales corporation (DISC) pursuant to section 992.
On March 22, 1972, petitioner and International entered into a written agreement entitled "Commission Agreement" appointing International as*34 "sales agent" for petitioner. The commission agreement, in effect during 1981, provided that commissions payable to International on petitioner's qualified export receipts would equal the maximum amount allowable under
On February 1, 1980, petitioner and International entered into an agreement entitled "Agreement Designating Foreign Marketing Departments and Related Intercompany Accounts" (foreign marketing agreement). The foreign marketing agreement, in effect during 1981, provided that petitioner and International agree "to designate certain departments * * * as Foreign Marketing Departments for the purpose of accounting for export promotion expenses to be incurred by CV International." The agreement further provided that the employees of petitioner's foreign marketing departments would be deemed employees of International. However, petitioner would "carry out all human resource functions with respect to these employees" and *655 "act as a common paymaster, or as agent for CV International with respect to periodic payroll payments and with respect to the federal and state income, social security, and unemployment tax withholdings, and reporting obligations of*35 CV International."
During 1981, petitioner treated the following expenses as export promotion expenses incurred by International pursuant to the foreign marketing agreement:
| Expense | Amount |
| Advertising | $ 13,751 |
| Salaries and wages | 610,506 |
| Rents | 56,164 |
| Employee benefit program | 169,343 |
| Other: | |
| Travel | 478,812 |
| Telephone/telegraph | 304,939 |
| Training | 14,866 |
| Training/documentation | 699,393 |
| Relocation | 147,528 |
| Professional services | 21,418 |
| Contract labor services | 46,148 |
| Conferences/meetings | 85,274 |
| Marketing/public relations | 6,695 |
| Project materials | 41,196 |
| Legal and audit | 6,880 |
| Dues and subscriptions | 20,924 |
| Leased equipment | 6,560 |
| Expendable materials | 11,361 |
| Miscellaneous | 3,626 |
| 2,745,384 |
On January 31, 1981, petitioner and International entered into an agreement entitled "Accounts Receivable Purchase Agreement" (purchase agreement). Pursuant to the purchase agreement, International received, at a discount from face value, undivided interests in petitioner's accounts receivable arising from export sales on which International had earned a commission. The following transactions were consummated between petitioner and International pursuant*36 to the purchase agreement during 1981:
| Face amount | |
| Date of transfer | of receivables |
| 02/02/81 | $ 16,026,867 |
| 02/28/81 | 3,583,716 |
| 10/01/81 | 23,345,288 |
| 10/15/81 | 1,874,000 |
| 12/01/81 | 4,028,369 |
*656 During 1981, the discount from face value on accounts receivable transferred by petitioner to International totaled $ 4,661.026.
Petitioner was obligated by the purchase agreement to produce, upon demand by International, a list of the accounts receivable in which International had an interest, including the identity of the account debtor, the amount of each account receivable, and the date on which it arose. However, petitioner was required to bill and collect the accounts receivable on International's behalf and, unless requested to remit the proceeds to International, provide International with an undivided interest in additional accounts receivable for those discharged.
On its 1981 Federal income tax return, petitioner claimed deductions for commissions payable to International in the amount of $ 9,773,168, representing 50 percent of the combined taxable income of petitioner and International, and $ 324,044 (see
Congress created the DISC in the Revenue Act of 1971, Pub. L. 92-178, 85 Stat. 535, as a tax incentive designed to stimulate exports of domestic products. The legislation was enacted to eliminate tax disadvantages confronting domestic production firms engaged in exporting through domestic corporations as opposed to foreign manufacturing subsidiaries.
In general, a corporation that qualifies as a DISC is not taxable on its profits. Sec. 991. Instead, the DISC's shareholder is taxed each year on a specified portion of the DISC's earnings and profits as deemed distributions, while the remaining portion of profits is not taxed until actually withdrawn from the DISC or until the erstwhile DISC ceases to qualify as a DISC. Sec. 995.
To ensure that*38 a DISC's tax-deferred profits are used for export activities, Congress provided strict requirements for *657 qualification as a DISC.
Because of minimal capitalization and organizational requirements, a DISC may be no more than a corporation that serves primarily as a bookkeeping device to measure the amount of export earnings that are subject to tax deferral.
Intercompany pricing rules for a DISC and its related supplier are contained in
(1) 4 percent of the qualified export receipts on the sale of such property by the DISC plus 10 percent of the export promotion expenses of such DISC attributable to such receipts. (2) 50 percent of the combined taxable income of such DISC and such person which is attributable to the qualified export receipts on such property derived as the result of a sale by the DISC plus 10 percent of the*40 export promotion expenses of such DISC attributable to such receipts, or (3) taxable income based upon the sale price actually charged (but subject to the rules provided in section 482).
Thus,
The transfer pricing rules provide the means for allocating taxable income from an export sale between the DISC and its related supplier. Generally, intercompany pricing is made on a transaction-by-transaction basis. However, at the annual choice of the taxpayer*41 some or all of the pricing may be made on the basis of groups consisting of products or product lines.
Although the three intercompany pricing methods contained in
(6)
*659 (iii) Costs (other than cost of goods sold) which shall be treated as relating to gross receipts from sales of export property are (a) the expenses, losses, and other deductions definitely related, and therefore allocated and apportioned, thereto, and (b) a ratable part of any other expenses, losses, or other deductions which are not definitely related to a class of gross income, determined in a manner consistent with the rules set forth in
Thus, CTI of a DISC and its related supplier from a sale of export property generally is computed by reducing gross receipts as defined in section 993(f) by the expenses, losses, and other deductions definitely related to such receipts, plus a ratable part of any other expenses, losses, and other deductions not definitely related to a class of gross income consistent with the rules of
The regulations further provide that, subject to certain specified exceptions, the taxpayer's method of accounting used in computing CTI will be accepted.
In the case of a commission DISC, the gross income of the DISC is deemed to be the gross receipts derived by the principal from the sale, lease, or rental of the property on which the commissions arose. Sec. 993(f);
As an alternative to the full costing method for determining CTI,
We discussed the purpose and effect of the OPPL in
The marginal costing method may be used to compute CTI only if CTI so computed is higher than that computed under the full costing method.
In addition to commission income, a DISC may earn income from the collection of accounts receivable transferred to it by the related party at a discount from face value. Under the statutory scheme, such transactions provide three specific benefits. First, the transferred accounts receivable constitute qualified export assets in the hands of the DISC and may be included to satisfy the 95-percent qualified export assets requirement of section 992(a)(1)(B). See H. Rept. 92-533,
In the case before us, petitioner calculated International's commission by applying the intercompany pricing method contained in
CTI for the SDE and NAD product lines was computed under the full costing method. CTI for the Far East, Cobilt, and Parts product lines was computed under the marginal costing method as limited by the OPPL.
For purposes of computing CTI, petitioner treated the discount of $ 4,661,026 arising from its transfer of accounts receivable to International as interest expense. International treated the same amount as interest income. Petitioner allocated the discount among its product lines as follows:
| Product line | Discount | Total |
| SDE | $ 1,263,279 | |
| NAD | 78,429 | $ 1,341,708 |
| Far East | 301,431 | |
| Cobilt | 137,164 | |
| Parts | 438,595 | |
| 1,780,303 | ||
| Domestic lines | 1,702,693 | |
| Other income | 1,178,030 | |
| 4,661,026 |
Petitioner calculated the export promotion expense component of International's commissions by combining the export promotion expenses of $ 2,745,384 arising under the foreign marketing agreement with sales commission expenses of $ 495,066 for a total of $ 3,240,450. Ten percent of this latter figure, or $ 324,044, *48 was included in the commission payable to International.
*662 The issues for decision are: (1) Whether petitioner properly allocated discount to domestic product lines and other income in computing CTI under the full costing method; (2) whether petitioner properly computed CTI under the marginal costing method as limited by the OPPL by including discount as a component of the numerator of the OPP; and (3) whether petitioner properly computed International's export promotion expenses by including expenses "incurred" by International pursuant to the foreign marketing agreement.
Petitioner contends that the discount incurred on the transfer of accounts receivable to International was properly allocated among all seven of its product lines (foreign and domestic), as well as its other income, in accordance with
Respondent argues that petitioner must allocate the discount in question exclusively to its product lines generating export receipts under
Petitioner counters that
(v) If an account receivable arising with respect to a sale of export property is transferred by the related supplier to a DISC which is a member of the same controlled group within the meaning of section 1.993-1(k) for an amount reflecting a discount from the selling price taken into account in computing (without regard to this subdivision) combined taxable income of the DISC and its related supplier, then the combined taxable income from such sale shall be reduced by the amount of the discount.
Thus, under this regulation, if accounts receivable are transferred from a related supplier to its DISC at a discount from the face amount of the receivable, then full costing CTI is reduced by the amount of the discount.
*663 Petitioner argues, as did the taxpayer *50 in
The DISC legislation was intended to encourage domestic corporations to export U.S. goods. See H. Rept. 92-533,
The regulation prevents the amount of income measured by the discount from being taken into account twice in determining DISC taxable income -- first as a component of CTI, and second as a qualified export receipt included in DISC taxable income but excluded from CTI.
Accord
We are not persuaded that we should modify our views on this issue as expressed in
Petitioner computed CTI -- combined taxable income -- for the Far East, Cobilt, and Parts product lines under the marginal costing method subject to the OPPL -- the overall profit percentage limitation. Petitioner contends that discount is properly incorporated into the OPPL as a reduction *664 from full costing CTI in the numerator of the OPP -- the overall profit percentage.
Respondent argues that discount should be accorded consistent treatment whether CTI is computed under full cost or marginal cost accounting. Consequently, respondent argues that discount should be subtracted in full directly from the OPPL.
(2)
(
(
[Emphasis added.]
Thus, the OPP for a product or product line can be summarized by the following formula:
OPP = CTI (Full Costing) + Other Taxable Income (OTI) (from product or product line) / Total Gross Receipts (TGR) (from product or product line)
The OPPL is in turn computed by multiplying the DISC's gross receipts (DGR) from the product or product line by the OPP.
As noted, the parties disagree on the manner in which the discount in question is to be incorporated into the OPPL *665 formula. The parties' respective positions are reflected in the following formulas: OPPL = ([CTI - DISCOUNT] + OTI) / TGR X DGR OPPL = ([CTI + OTI] / TGR X DGR) - DISCOUNT
CTI means the full costing combined taxable income of the DISC and its related supplier;
OTI means all "other" taxable income from the productline realized by the related supplier, excluding CTI;
TGR means the total gross receipts from the product line; and
DGR means the gross receipts of the DISC from the product line.
We agree with petitioner.
In contrast, there is no express support in the regulations for respondent's position that discount is to be subtracted directly from the OPPL. In fact, there simply is no mention of discount in the regulations prescribing the rules for marginal cost accounting.
To the extent that the Secretary was directed by
Petitioner and International entered into a designation agreement for the purpose of accounting for export promotion expenses to be incurred by International. The agreement provided that the employees of petitioner's foreign marketing departments would be deemed employees of International.
Respondent determined that International did not incur export promotion expenses under the designation agreement because International did not perform substantial economic functions as required by
Petitioner maintains that International did incur export promotion expenses by virtue of the designation agreement. Petitioner argues that:
Petitioner and International were parties to an effective Foreign Marketing Agreement designating Foreign Marketing Departments. Pursuant to the agreement, certain expenses of a type described in
The transfer pricing rules of
The regulations contain detailed rules respecting the proper treatment of export promotion expenses. In this regard,
(2)
*58 Thus, a DISC may be allocated income by virtue of the transfer pricing rules of
The regulations defining the term "export promotion expenses" provide further limitations with respect to the proper treatment of export promotion expenses. In particular, the general definition of export promotion expenses contained in
In addition,
(7)
* * * *
(iii)
* * * *
(vi) An expense may be incurred by the DISC under subdivisions (i) through (v) of this subparagraph even if the accounting for and payment of such expense is handled by a related party and the DISC reimburses the related party for such expenses.
Although
To summarize, the regulations provide that export promotion expenses are*61 limited to the ordinary and necessary expenses incurred by a DISC for the purpose of advancing the sale, lease, or other distribution of export property. Petitioner has not raised an issue as to the validity of any of the aforementioned regulatory provisions.
The parties do not agree, however, whether the expenses were incurred or may be treated as incurred by International. Petitioner asserts that the designation agreement was valid and served to make the employees of its foreign *669 marketing departments the employees of International. Petitioner further asserts that the arrangement for the reimbursement of expenses from International to petitioner conforms with the transaction described in
It is respondent's position that the designation agreement was of no substantive effect and that since International was concededly a shell corporation, International did not incur the expenses in question.
Petitioner has the burden of proving that respondent's determination is incorrect. Rule 142. Notwithstanding the stringent requirements of the regulations, *62 petitioner introduced no supporting evidence or testimony, other than the designation agreement, to counter respondent's determination.
While a DISC is recognized as a separate corporate entity so long as minimal organizational requirements are satisfied,
The designation agreement, standing alone, is insufficient to establish that International incurred expenses in carrying on a trade or business. See
Likewise, the designation agreement falls short of proving that the expenses were incurred by International as opposed *670 to petitioner.
On the whole, the record suggests that International was organized and operated solely as an accounting device for computing income subject to deferral under the DISC provisions. We can only assume*64 that if petitioner possessed additional evidence demonstrating that International actually incurred trade or business expenses, such evidence would have been included in the stipulation or otherwise presented to the Court.
Under the circumstances, we must conclude that petitioner continued to conduct its export business in the same manner as it had prior to the effective date of the designation agreement. In this respect, the employees of petitioner's foreign marketing departments were "employees" of International in name only. We find that the expenses in question were not incurred by International as contemplated under
To reflect the foregoing, as well as concessions made by the parties,