Gen. Dynamics Corp. & Subsidiaries v. Comm'r of Internal Revenue

• Decision Date: 26 March 1997
• Docket Number: 19203-94.,No. 19202-94,19202-94
• Citation: 108 T.C. 107,108 T.C. No. 9
• Parties: GENERAL DYNAMICS CORPORATION AND SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.GENERAL DYNAMICS FOREIGN SALES CORP., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

108 T.C. 107

108 T.C. No. 9

GENERAL DYNAMICS CORPORATION AND SUBSIDIARIES, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.GENERAL DYNAMICS FOREIGN SALES CORP., Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 19202-94

19203-94.

United States Tax Court.

March 26, 1997.

David C. Bohan, Richard T. Franch, James M. Lynch, Philip A. Stoffregen, David D. Baier, Scott Schaner, Gregory S. Gallopoulos, and Debbie L. Berman, for petitioner in docket No. 19202-94.

David C. Bohan, James M. Lynch, Philip A. Stoffregen, and David D. Baier, for petitioner in docket No. 19203-94.

William H. Quealy, Jr., Alice M. Harbutte, Jeffrey A. Hatfield, Thomas C. Pliske, and William T. Derick, for respondent.GERBER, Judge:

General Dynamics Corp. and its consolidated subsidiaries (GENDYN) ( docket No. 19202-94) and its foreign sales corporation, General Dynamics Foreign Sales Corp. (GENDYN/FSC) (docket No. 19203-94), are petitioners in these consolidated cases. Respondent determined corporate income tax deficiencies for GENDYN in the amounts of $26,118,976 and $291,218,973 for its 1985 and 1986 taxable years, respectively. With respect to GENDYN/FSC, respondent determined a $586,533 corporate income tax deficiency for its 1986 taxable year. Although these cases are consolidated and related, for purposes of briefing and opinion the issues have been divided into two generalized categories: Domestic and foreign. This opinion addresses the foreign issues.

The parties have settled some of the foreign issues, and the following controversies remain for our consideration and decision: (1) Whether in computing combined taxable income attributable to qualified export receipts under sections 994¹ and 925 petitioners must, in addition to current year period costs, deduct prior year period costs, as determined by respondent; and (2) whether two liquefied natural gas tankers manufactured by petitioner and sold to an unrelated third party for foreign use constitute export property under section 993(c)(1) even though no foreign use occurred during the first year and/or domestic use occurred on one occasion prior to any foreign use.

FINDINGS OF FACT

The parties have stipulated most of the facts bearing on the foreign issues, and those facts are found and incorporated by this reference. GENDYN was incorporated on February 21, 1952, and, at all relevant times, was the common parent of a group of corporations that filed consolidated corporate Federal income tax returns. At the time the petitions were filed in these cases, GENDYN's and GENDYN/FSC's principal places of business were in Falls Church, Virginia. GENDYN engineered, developed, and manufactured various products for the U.S. Government and, to a lesser extent, foreign governments, including military aircraft, missiles, gun systems, space systems, tanks, submarines, electronics, and other miscellaneous goods and services. GENDYN was also involved in business activities, including design, engineering, and manufacture of general aircraft; mining coal, lime, limestone, sand, and gravel; manufacture and sale of ready-mix concrete, concrete pipe, and other building products; production of commercial aircraft subassemblies; design, engineering, and manufacture of commercial space launch vehicles and services; and shipbuilding. GENDYN, for the taxable years 1977 through 1986, used the completed contract method to report Federal income and the percentage of completion method for its financial accounting purposes.

GENDYN, on February 25, 1972, incorporated an entity (GENDYN/DISC)² to serve as an export sales representative. GENDYN owned 100 percent of GENDYN/DISC's sole class of voting stock. GENDYN/DISC had no employees or business operations and existed for the sole purpose of receiving commissions from GENDYN. On the date of the incorporation, GENDYN and GENDYN/DISC entered into an Export Sales Commission Agreement. On May 24, 1972, GENDYN/DISC elected to be treated as a domestic international sales corporation (DISC) under section 992(b), and it filed Federal income tax returns (Forms 1120-DISC) on the basis of a fiscal year ended March 31.

GENDYN/DISC, through the period ended December 31, 1984, reported the commissions it earned on GENDYN's sales of export property based on the completed contract method of accounting in accordance with section 1.993-6(e)(1), Income Tax Regs.

At the end of each year, commissions on export property sales involving long-term contracts were deducted by GENDYN and included in income by GENDYN/DISC in its appropriate taxable period. Commissions were normally computed under the 50-50 combined taxable income method (50-percent method) provided for in section 994 because that method yielded the largest commission. On certain rare occasions, the 4-percent gross receipts method of section 994 was utilized.

Petitioners computed combined taxable income for each long-term contract under the 50-percent method, as follows:

(a) Add: gross receipts from the contract as determined under the completed contract method of accounting;

(b) Less: direct costs allocated to the contract under section 1.451-3(d)(5)(i), Income Tax Regs.;

(c) Less: indirect costs allocated to the contract under section 1.451-3(d)(5)(ii), Income Tax Regs.;

(d) Less: period costs incurred in the year of completion allocated to the contract under section 1.451-3(d)(5)(iii), Income Tax Regs.

In computing combined taxable income, petitioners did not make a reduction for period costs, as defined in section 1.451-3(d)(5)(iii), Income Tax Regs., incurred and allocated to the contract prior to the year of contract completion. Respondent determined that petitioners incorrectly computed combined taxable income under the 50-percent method. In particular, respondent determined that petitioners were required to aggregate and deduct, in the year of completion of each long-term contract, all period costs allocated to the contract, including those deducted for prior years.

GENDYN/DISC ceased performing as GENDYN's commission agent on December 31, 1984, and was dissolved on October 23, 1992.

On December 27, 1984, GENDYN incorporated petitioner General Dynamics Foreign Sales Corp. (GENDYN/FSC) in the U.S. Virgin Islands to serve as GENDYN's export sales representative. GENDYN owned the sole class of voting stock and entered into a Foreign Sales Commission Agreement with GENDYN/FSC. On March 22, 1985, GENDYN/FSC elected under section 927(f) to be treated as a foreign sales corporation (FSC). During 1985 and 1986, GENDYN/FSC functioned as GENDYN's export sales representative and was involved in no other trade or business. GENDYN/FSC filed Federal Forms 1120-FSC and used the completed contract method of accounting to report the commissions earned on GENDYN's sales of export property involving long-term contracts.

At the end of each year, commissions on export property sales involving long-term contracts were deducted by GENDYN and included in income by GENDYN/FSC in its appropriate taxable period. With rare exceptions, the 23-percent combined taxable income method (23-percent method) was used because it produced the largest commission. In a few instances, the 1.83-percent gross receipts method was used.

Petitioners computed combined taxable income for each long-term contract under the 23-percent method as follows:

(a) Add: gross receipts from the contract as determined under the completed contract method of accounting;

(b) Less: direct costs allocated to the contract under section 1.451-3(d)(5)(i), Income Tax Regs.;

(c) Less: indirect costs allocated to the contract under section 1.451-3(d)(5)(ii), Income Tax Regs.;

(d) Less: period costs incurred in the year of completion allocated to the contract under section 1.451-3(d)(5)(iii), Income Tax Regs.

In computing combined taxable income, petitioners did not make a reduction for period costs incurred prior to the year of contract completion that had been allocated to the contract in years prior to completion under section 1.451-3(d)(5)(iii), Income Tax Regs. Respondent determined that petitioners incorrectly computed combined taxable income under the 23-percent method. In particular, respondent determined that petitioners, in the year of completion of each long-term contract, were required to aggregate all period costs allocated to the contract, including those deducted for prior years, and reduce combined taxable income by the aggregated amount.

Respondent also determined that GENDYN was not entitled to deduct commissions on sales involving two ships because they did not qualify as export property under section 993. In the alternative, if the ships are found to qualify as export property under section 993, respondent determined that petitioners incorrectly computed the commissions attributable to the ships, in the same manner as described above.

Pantheon, Inc. (Pantheon), is a wholly owned domestic subsidiary of GENDYN. Pelmar Co. (Pelmar) and Morgas, Inc. (Morgas), are wholly owned domestic subsidiaries of corporations unrelated to petitioners. On May 7, 1976, Pantheon, Pelmar, and Morgas formed the Lachmar Partnership (Lachmar), a general partnership. Pantheon and Pelmar each owned 40 percent, and Morgas owned the remaining 20 percent of Lachmar. Lachmar was organized for the purpose of purchasing, owning, and operating two specialized vessels (LNG tankers) that were designed and built for transoceanic transport of liquefied natural gas (LNG).

LNG is made by cooling natural gas to a temperature below minus 256 degrees Fahrenheit. It is then transported at that temperature in special-purpose tankers. After delivery from the tankers, the LNG is returned to a state in which it can be distributed through pipelines. The construction of LNG tankers incorporates specialized and expensive technology which when installed in a tanker renders it economically unusable for other transportation purposes. Due to the cost to specially build them and the...