R.T. French Co. v. Comm'r of Internal Revenue

• Decision Date: 06 September 1973
• Docket Number: Docket Nos. 5026-70— 5028-70.
• Citation: 60 T.C. 836
• Parties: THE R. T. FRENCH COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

60 T.C. 836

THE R. T. FRENCH COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 5026-70— 5028-70.

United States Tax Court

Filed September 6, 1973.

Frederick D. H. Gilbert, Robert B. Ross, and Donald G. Koch, for the petitioners.

L. William Fishman and Bernard Goldstein, for the respondent.

1. Held: Royalty payments to T. corp. to an affiliated foreign company were made pursuant to licensing arrangements such as would have been entered into by parties dealing at arm's length. The royalty expenses were therefore deductible under sec. 162(a) of the 1954 Code, and the Commissioner's disallowance of such deductions under the claimed authority of sec. 482 of the Code was improper.

2. T concedes that income must be imputed to it by reason of free use by its foreign ‘brother-sister’ affiliates of certain intangible assets owned by T. T will never receive actual payment from the affiliates for their use of such assets. Held, the British parent of T and its affiliates did not receive a ‘constructive dividend’ in the circumstances of this case, and T therefore was not required to ‘withhold’ income tax on any such ‘dividend’ under sec. 1442(a) of the Code.

The Commissioner determined deficiencies in petitioner's income tax in the amount of $60,699.15 and $70,594.59 for the taxable years ending December 28, 1963, and January 2, 1965, respectively, and deficiencies in petitioner's withholding (section 1442(a)) tax in the amounts of $5,836.50 and $7,059.46 for the calendar years 1963 and 1964, respectively. The only issues remaining for decision are: (1) whether the Commissioner properly allocated income to petitioner, pursuant to section 482 of the 1954 Code, by reason of its participation in certain licensing arrangements with affiliated foreign companies; and (2) whether the free use by petitioner's brother-sister foreign organizations of certain intangible assets owned by it represented constructive dividends to the foreign parent company upon which petitioner was required to withhold income tax pursuant to section 1442(a) of the Code.

FINDINGS OF FACT

The parties have stipulated to certain facts and exhibits which are incorporated herein by this reference.

R. T. French Co. (French or petitioner) is a Delaware corporation engaged in the business of manufacturing and distributing various food products and other merchandise. Its principal business office was in Rochester, N.Y., at the time of the filing of its petition herein.

At all times prior to January 1, 1959, petitioner kept its books and filed its income tax returns on the basis of the calendar year. At all times on and after January 1, 1959, it has kept its books and filed its income tax returns on the basis of a fiscal year consisting of a period ending on the Saturday nearest to the 31st day of December in each calendar year. See section 441(e) and (f), I.R.C. 1954. Unless otherwise indicated by the context, reference herein to a particular tax year of petitioner after 1958 without further identification will mean that fiscal year the greater portion of which was included in the particular year referred to (e.g., the ‘year 1964’ means petitioner's fiscal year ending January 2, 1965).

For a number of years French has distributed certain instant mashed potato products in granular form— more fully described hereinafter— that it has manufactured under various processes derived from one invented by Theodore Rendle, an employee of Chivers & Sons Ltd. (Chivers), a British company. Chivers had acquired Rendle's British patent from him, during World War II it engaged in the United Kingdom in the first successful effort to develop an instant mashed potato product that was exploited commercially. Chivers applied for a U.S. patent in 1943 and was granted such a patent on August 7, 1945, but never itself produced or marketed the product in this country.

Chivers had insufficient capital to put the new process fully into use on its own, and it made overtures to a British firm by the name of Reckitt & Colman Ltd., which had not only sufficient capital but also substantial overseas interests that were expected to contribute to foreign exploitation of the Rendle patents. Chivers and Reckitt & Coleman Ltd. thus entered into a joint venture on or about January 1, 1946, organizing a new British company known as M.P.P. (Products) Ltd. (MPP) and to which Chivers transferred all of its rights in the British and U.S. patents relating to the Rendle process and also certain of the plant facilities it had earlier used in its modest implementation of that process. Chivers took 49 percent of the shares of MPP's capital stock and assumed chief responsibility for production and technical and research aspects of the new enterprise, and Reckitt & Colman Ltd. took 51 percent of the MPP stock and became in charge of marketing. MPP never had any employees of its own; its activities were carried on in its name by its parent companies. During the continuance of their joint venture in MPP, both Chivers and Reckitt & Colman Ltd. were represented on the MPP board of directors.

At all times relevant hereto until the year 1955, 55 percent of petitioner's outstanding capital stock was owned by J. & J. Colman Ltd., a British company, and the remaining 45 percent of such stock was owned by Reckitt & Sons Ltd. also a British company, or by a wholly owned subsidiary known as Reckitts (U.S.A.) Ltd. J. & J. Colman Ltd. and Reckitt & Sons Ltd. were then entirely independent of one another, and neither company possessed or exercised any control over the other through stock ownership or otherwise. They did, however, own or control the stock in Reckitt & Colman Ltd., referred to above, which, together with Chivers, had organized MPP.

In 1954¹ J. & J. Colman Ltd. and Reckitt & Sons Ltd. were reorganized to form a single British company known as Reckitt & Colman (Holdings) Ltd., which from that time forward has controlled all of petitioner's stock either directly or through its subsidiaries. Reckitt & Colman (Holdings) Ltd. and its subsidiaries are sometimes collectively referred to hereinafter as the Reckitt & Colman group, or simply Reckitt & Colman; however, use of the term ‘Reckitt & Colman’ in a context involving periods prior to 1954 is intended to refer to the company which, together with Chivers, had organized MPP in 1946.

On June 20, 1960, Reckitt & Colman acquired Chivers' 49-percent interest in MPP, and in December of 1961 all of the assets and business of MPP were consolidated by merger into one of the constituents of the Reckitt & Colman group, J. & J. Colman Ltd. (which was a different entity from the previously mentioned firm of the same name). After June 20, 1960, both French and MPP were thus 100-percent-owned by Reckitt & Colman interests. None of the aforementioned British companies, including Chivers, has been engaged in the conduct of any trade or business within the United States at any time relevant to these proceedings.

On August 13, 1946, French and MPP entered into a license agreement in respect of the Rendle mashed potato process. As previously indicated, all of French's stock was then owned by the two British companies which, through ownership of all the stock in Reckitt & Colman, controlled 51 percent of the stock of MPP. Under the agreement, MPP in substance purported to grant to petitioner an exclusive license to manufacture and sell within the United States the instant mashed potato product in accordance with the so-called Rendle patent, and it undertook to provide the ‘know-how’ required to work the process (including any improvements and further inventions), furnishing technical advice and assistance throughout the entire term of the agreement. The licensee agreed, without payment therefor, to make available to the licensor any improvements or further inventions which the licensee might discover. Although the U.S. patent was due to expire on August 7, 1962, the agreement was to run until June 1, 1967. The agreement required the licensee to pay a royalty of 3 percent of its net sales. It further provided that if the licensee's obligation to pay this royalty should terminate prior to June 1, 1967 (e.g., upon expiration of the patent in 1962), the licensee would be required, after such termination and until June 1, 1967, to pay a net amount of 1 percent of its net sales for the advice and assistance of the licensor relating to the production of the mashed potato product.

On December 13, 1956, the foregoing agreement was amended to change the amount of the royalty to 3 percent of net sales up to net sales of $800,000 in any calendar year plus 2 percent of net sales of any excess over that amount in any such year.

On or about March 14, 1950, French had entered into a separate and unrelated agreement with Reckitt & Colman whereby the British firm undertook to supply French with the fruits of certain research it was conducting in areas apart from the mashed potato field and into which French was contemplating eventual expansion. French undertook to pay L5,000 a year under that agreement, and pursuant thereto it paid $13,984 and $13,951, for the years 1963 and 1964, respectively.

The Rendle process, as put into operation by French after 1946, entailed, in short, cooking and mashing of raw potatoes, admixture of the mash with ‘seed powder,‘ and dehydration of the resulting material under carefully controlled conditions to yield granules that could be reconstituted into mashed potatoes suitable for consumption by the addition of water or milk. The entire process required approximately 2 hours. The ‘seed powder’ consisted of the finished granules themselves, and the ‘adding back’ of that powder was fundamental to the Rendle process. French obtained seed powder from MPP (or Chivers) until it produced sufficient amounts of powder to fulfill its own needs.

The Rendle process could not readily be instituted without special equipment and...