Seagate Tech., Inc. v. Comm'r of Internal Revenue
| Decision Date | 08 February 1994 |
| Docket Number | No. 11660–90.,11660–90. |
| Citation | 102 T.C. 149,102 T.C. No. 9 |
| Parties | SEAGATE TECHNOLOGY, INC. and Consolidated Subsidiaries, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
102 T.C. 149
102 T.C. No. 9
SEAGATE TECHNOLOGY, INC. and Consolidated Subsidiaries, Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
No. 11660–90.
United States Tax Court
Feb. 8, 1994.
[102 T.C. 150]
Joel V. Williamson, William A. Schmalzl, Joseph R. Goeke, John Bleveans, Thomas C. Durham, Roger J. Jones, M. Ellen Robb, Clisson S. Rexford, and Scott M. Stewart, Chicago, IL, for petitioner.
William E. Bonano, San Francisco, CA, John O. Kent, Los Angeles, CA, Christopher J. Croudace, Christopher J. Faiferlick, San Jose, CA, and Paul G. Robeck, Portland, OR, for respondent.
[102 T.C. 149]
P, a corporation whose stock is publicly traded, is a leading manufacturer of hard disk drives for personal computers. During its fiscal year ended 1983, P organized S as a wholly owned subsidiary to manufacture component parts in Singapore for use by P in the manufacture of hard disk drives in the United States. During its fiscal year ended 1984, P expanded S's operations to include the manufacture of completed disk drives in Singapore. P contributed to S's capital certain intangibles for use in the manufacture of the completed disk drives. P purchases component parts from S for use in disk drives P manufactures in the United States. P also purchases completed disk drives from S for resale to third parties. P generally pays S's standard cost plus a markup of 25 percent for the component parts and completed disk drives. S also sells component parts and completed disk drives directly to its third party customers. Pursuant to a property transfer agreement, S agreed to pay P a royalty of 1 percent of certain “sales into the United States”. Pursuant to a marketing agreement, S agreed to pay P a commission of 5 percent on all of S's third party sales, except for sales to distributors in Southeast Asia, the Indian Subcontinent, and the China Basin. Pursuant to a services agreement, S agreed to pay P for certain costs P incurred in assisting S's operations. Pursuant to a cost-sharing agreement, S agreed to pay P for one-half of the research and development costs P incurred and identified as covered under the cost-sharing arrangement. S also agreed to reimburse P for certain warranty costs incurred by P's repair centers. On audit, R reallocated income from S to P pursuant to sec. 482, I.R.C. 1954. Held, respondent's reallocation of income to P is arbitrary, capricious, and unreasonable. Held, further: R does not bear the burden of proof for issues in the case, except as specifically noted in the opinion. Held, further: The royalty rate contained in the property transfer agreement is not an arm's-length royalty rate, and the transfer prices for the component parts and completed disk drives are not arm's-length prices. Sec. 1.482–2(d) and (e), Income Tax Regs., applied to determine the proper sec. 482 adjustments for royalty and component parts and completed disk drive issues. Held, further: P's definition of “sales into the United States” is not reasonable. Such term is defined to include all disk drives shipped to U.S. destinations regardless of where title to the property is transferred. Held, further: S paid P arm's-length procurement service fees. Sec. 1.482–2(b), Income Tax Regs., applied. Held, further: Fifty percent of the research and development costs is not an arm's-length share. Sec. 1.482–2(d), Income Tax Regs., applied to determine the proper arm's length share. Held, further: P is not entitled to an offset for warranty payments S paid P. Sec. 1.482–1(d)(3), Income Tax Regs., applied.
+-----------------------------------------------------------------------------+
¦CONTENTS ¦
+-----------------------------------------------------------------------------¦
¦ ¦ ¦ ¦ ¦ ¦ ¦Page¦
+------------------------------------------------------------------------+----¦
¦STATEMENT OF ISSUES ¦8 ¦
+------------------------------------------------------------------------+----¦
¦I. ¦GENERAL FINDINGS OF FACT ¦9 ¦
+-----+------------------------------------------------------------------+----¦
¦ ¦A.¦Background in General ¦10 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦B.¦The Industry in General ¦11 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦C.¦Seagate Scotts Valley ¦13 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦D.¦Seagate Singapore ¦14 ¦
+-----+------------------------------------------------------------------+----¦
¦II. ¦ISSUE 1: WHETHER RESPONDENT'S REALLOCATIONS OF GROSS INCOME UNDER ¦16 ¦
¦ ¦SECTION 482 ARE ARBITRARY, CAPRICIOUS, AND UNREASONABLE ¦ ¦
+-----+------------------------------------------------------------------+----¦
¦ ¦A.¦FINDINGS OF FACT ¦16 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦The Notices of Deficiency ¦16 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦Respondent's Expert Reports ¦16 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦B.¦OPINION ¦18 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦The Parties' Positions ¦18 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦Section 482 in General ¦18 ¦
+-----+------------------------------------------------------------------+----¦
¦III. ¦ISSUE 2: WHETHER RESPONDENT SHOULD BEAR THE BURDEN OF PROOF FOR ¦21 ¦
¦ ¦ANY OF THE ISSUES INVOLVED IN THE INSTANT CASE ¦ ¦
+-----+------------------------------------------------------------------+----¦
¦ ¦A.¦FINDINGS OF FACT ¦21 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦The Notices of Deficiency ¦21 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦Respondent's Concessions ¦24 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦3. ¦Respondent's Experts ¦25 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦B.¦OPINION ¦26 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦The Parties' Positions ¦26 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦The Court's Holding as to Burden of Proof ¦27 ¦
+-----+------------------------------------------------------------------+----¦
¦IV. ¦ISSUE 3: WHETHER SEAGATE SCOTTS VALLEY PAID SEAGATE SINGAPORE ¦32 ¦
¦ ¦ARM'S–LENGTH PRICES FOR COMPONENT PARTS ¦ ¦
+-----+------------------------------------------------------------------+----¦
¦ ¦A.¦FINDINGS OF FACT ¦32 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦In General ¦32 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦Intercompany Transactions ¦33 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦3. ¦Component Parts Manufacturing ¦34 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦4. ¦Respondent's Notices of Deficiency ¦37 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦5. ¦Petitioner's Experts ¦38 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦ ¦a.¦Daniel P. Broadhurst ¦38 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦b.¦Gary E. Holdren ¦38 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦c.¦Clark J. Chandler ¦39 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦6. ¦Respondent's Experts ¦45 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦ ¦a.¦Thomas Horst ¦45 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦b.¦Grant M. Clowery ¦46 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦c.¦Steven M. Zemsky ¦49 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦7. ¦Other Third Party Transactions ¦50 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦B.¦OPINION ¦51 ¦
+-----+--+---------------------------------------------------------------+----¦
¦ ¦ ¦1. ¦Ultimate Findings of Fact ¦51 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦2. ¦The Methods ¦51 ¦
+-----+--+-------+-------------------------------------------------------+----¦
¦ ¦ ¦ ¦a.¦The Comparable Uncontrolled Price (CUP) Method ¦53 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦i. ¦The CUP Method in General ¦53 ¦
+-----+--+-------+--+----+-----------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦ii. ¦The Parties' Positions on the CUP Method and ¦54 ¦
¦ ¦ ¦ ¦ ¦ ¦the Court's Holding as to Its Application ¦ ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦b.¦The Cost–Plus Method ¦56 ¦
+-----+--+-------+--+----------------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦i. ¦The Cost–Plus Method in General ¦56 ¦
+-----+--+-------+--+----+-----------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦ ¦The Parties' Positions on the Cost–Plus Method ¦ ¦
¦ ¦ ¦ ¦ ¦ii. ¦as Applied by Dr. Horst and the Court's Ruling ¦57 ¦
¦ ¦ ¦ ¦ ¦ ¦as to That Method ¦ ¦
+-----+--+-------+--+----+-----------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦ ¦The Parties' Positions on Applying the ¦ ¦
¦ ¦ ¦ ¦ ¦iii.¦Cost–Plus Method Using the Bull Peripheriques ¦63 ¦
¦ ¦ ¦ ¦ ¦ ¦Sale and the Court's Holding as to That Method ¦ ¦
+-----+--+-------+--+----+-----------------------------------------------+----¦
¦ ¦ ¦ ¦ ¦ ¦The Parties' Position on Applying the Cost–Plus¦ ¦
¦ ¦ ¦ ¦ ¦iv. ¦Method Using Dr. Chandler's Approaches and the ¦64 ¦
¦ ¦ ¦ ¦ ¦ ¦Court's Holding as to That Method ¦ ¦...To continue reading
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