108 T.C. 147 (T.C. 1997), 3173-95, Asat, Inc. v. Commissioner of Internal Revenue
|Citation:||108 T.C. 147, 108 T.C. No. 11|
|Opinion Judge:||VASQUEZ, Judge.|
|Party Name:||ASAT, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent|
|Attorney:||James E. Merritt, Linda A. Arnsbarger, and Thomas H. Steele, for petitioner. Mary E. Wynne, Michael F. Steiner, and Grace L. Perez-Navarro, for respondent.|
|Case Date:||March 31, 1997|
|Court:||United States Tax Court|
Decision will be entered for respondent.
P, a wholly owned domestic subsidiary, purchased assembly services from its parent, a foreign corporation. During an IRS audit of P's 1991 Federal corporate income tax return, the IRS notified P that it would need to be appointed its parent's limited agent under sec. 6038A(e)(1), I.R.C. P did not obtain the authorization of agent before R issued a notice of deficiency. Consequently, pursuant to sec. 6038A(e)(3), I.R.C., which grants the Commissioner the authority to determine in her sole discretion the cost of goods sold and deductions arising out of transactions between a domestic corporation and a related foreign corporation, R determined that P's cost of goods sold should be decreased and eliminated a net operating loss (NOL) carryforward which originated from P's 1989 and 1990 tax years. In addition, R disallowed P's deduction for consulting fees paid to an unrelated domestic corporation and applied the accuracy-related penalty.
Held, sec. 6038A, I.R.C., applies to P for the year at issue. Held, further, P failed to obtain the authorization of agent required by sec. 6038A(e)(1), I.R.C. Held, further, R did not abuse her discretion when she adjusted P's cost of goods sold and NOL under sec. 6038A(e)(3), I.R.C. Held, further, P may not deduct the consulting fees as it did not prove that the expense was ordinary and necessary. Held, further, P is liable for the accuracy-related penalty.
Respondent determined a deficiency in petitioner's Federal income tax in the amount of $ 407,592 and an accuracy-related penalty under section 6662(a)  of $ 81,518 for its taxable year ending April 30, 1991. Although respondent gave alternative grounds for each adjustment in the notice of deficiency, her first ground in regard to petitioner's cost of goods sold and net operating loss was section 6038A(e)(3), which grants the Commissioner the authority to determine in her sole discretion the cost of goods sold and expenses arising out of transactions between a domestic corporation and a related foreign corporation (the section 6038A issues). As resolution of the section 6038A issues could negate the need for a trial of issues involving section 482 (section 482 was an alternative ground for the adjustments), we conducted a separate trial of the section 6038A issues. With this background in mind, the issues for decision are:
(1) Whether section 6038A applies to petitioner for its tax year ending April 30, 1991; and, if so,
(2) whether there was a failure to authorize petitioner as its parent's agent under section 6038A(e)(1); and, if so,
(3) whether respondent's determination under section 6038A(e)(3), reducing petitioner's cost of goods sold by $ 1,494,437, was an abuse of discretion; 
(4) whether respondent's determination under section 6038A(e)(3), eliminating petitioner's NOL carryforward of $ 165,147, was an abuse of discretion;
(5) whether petitioner may deduct consulting fees of $ 280,922;  and
(6) whether petitioner is liable for the accuracy-related penalty under section 6662(a) for negligence.
FINDINGS OF FACT
Petitioner, ASAT, Inc., is a corporation organized under the laws of California. At the time the petition was filed, its principal place of business was in Palo Alto, California.
Petitioner's Organizational Structure
From December 22, 1988, to at least June 30, 1992 (a period which includes petitioner's fiscal year ended April 30, 1991, the year in issue), petitioner was a wholly owned subsidiary of ASAT, Ltd., a Hong Kong corporation. During its fiscal year ended April 30, 1991, ASAT, Ltd., was 85 percent owned by a subsidiary of QPL International Holdings Ltd. (QPL), a Bermuda corporation with offices in Hong Kong. Mr. Li Tung Lok (Mr. Li) was chairman of the board and the largest single shareholder of QPL during 1990 and 1991. Petitioner became 95 percent owned by Worltek International Ltd. (Worltek), a domestic corporation organized in California, when Worltek purchased 95 percent of petitioner's stock directly from petitioner on July 15, 1992. On November 9, 1994, QPL acquired 100 percent of the stock of Worltek. Hence, petitioner, once again, became an indirect subsidiary of QPL.
Petitioner's Business 
Petitioner located semiconductor companies (customers) that wanted their semiconductor dies put into an assembly package. These customers contracted with petitioner for assembly services to be provided by ASAT, Ltd., petitioner's foreign parent. Customers provided the product by drop shipment directly to ASAT, Ltd., in Hong Kong, for assembly. Petitioner
coordinated the transaction, sometimes handling the freight forwarding. ASAT, Ltd., invoiced petitioner, which then invoiced its customer for the agreed upon purchase price (the contract price). After the customer paid petitioner the contract price, petitioner paid the invoice received from ASAT, Ltd., by remitting 94 percent of the contract price to ASAT, Ltd., retaining 6 percent for itself.  During the fiscal year immediately prior to the year in issue, petitioner paid ASAT, Ltd., 100 percent of the amounts collected from petitioner's customers.  Petitioner reported its receipt of the contract price on its 1991 Federal corporate income tax return (tax return) as " Gross receipts or sales" . Petitioner reported its payments to ASAT, Ltd. for assembly services under " Cost of goods sold" . 
ASAT, Ltd., had no sales people located in the United States during its fiscal year ended April 30, 1991. Petitioner made purchases on behalf of ASAT, Ltd. There were no written agreements between petitioner and ASAT, Ltd., regarding the purchases petitioner made on ASAT, Ltd.'s, behalf. Petitioner paid for all advertising in the United States for itself and ASAT, Ltd.
Internal Revenue Service (IRS) Audit of Petitioner
Respondent's examination of petitioner's tax year ending April 30, 1991 (hereinafter the examination), began when a notification of the examination was sent to petitioner on July 17, 1992. The examination continued until December 21, 1994, the date the statutory notice of deficiency was issued. Nanette Alexander Hamilton was the International Examiner who examined petitioner's tax return for the tax year ended April 30, 1991. During the examination, Ms. Hamilton met with petitioner's tax counsel, Martin Schainbaum, and with Fe Maliwat, Robert Borawski, and Conrad Chapple, all representatives of petitioner. Ms. Maliwat was petitioner's
controller from April 13, 1991, to December 31, 1992. In addition to providing documents to Ms. Hamilton, Ms. Maliwat responded to inquiries and explained certain aspects of petitioner's business operations. Mr. Borawski was petitioner's counsel and corporate secretary during the examination. Mr. Chapple has been petitioner's chief financial officer and senior executive vice-president from January 1, 1993, to the present. Prior to 1993, Mr. Chapple was president of Worltek.
During the examination Ms. Hamilton issued 11 Information Document Requests (IDR's) to petitioner. Ms. Hamilton asked for the agreements and the basis of how the pricing, commissions, and service rates were established between petitioner and ASAT, Ltd., as well as agreements between petitioner, ASAT, Ltd., and unrelated parties. Petitioner never provided these documents, though petitioner provided copies of invoices to show actual pricing. By letter dated October 23, 1992, Ms. Hamilton advised petitioner's tax counsel that she relied on section 6038A as her authority to request the documents.
Ms. Hamilton requested a worldwide organization chart; Hong Kong income tax returns filed by ASAT, Ltd.; an audited financial statement of ASAT, Ltd., covering the period under examination; internal financial statements of ASAT, Ltd., broken down by product line and subsidiary location; and business plans, market studies, feasibility studies, corporate minutes, etc., conducted or developed by ASAT, Ltd., in relation to the organization and expectations for petitioner. This documentation was requested again in a section 6038A summons issued on October 5, 1993. During a meeting on September 24, 1992, Mr. Schainbaum advised Ms. Hamilton that petitioner would not produce the information requested on the grounds that the " taxpayer is not ASAT, Ltd." During the meeting on September 24, 1992, Ms. Hamilton advised Ms. Maliwat of section 6038A, that respondent had the authority to request documents concerning ASAT, Ltd., and that she needed the documents to conduct the examination. The worldwide organization chart, the Hong Kong income tax returns, audited financial statements, and certain internal financial statements of ASAT, Ltd., were provided to respondent on October 17, 1995, after the statutory notice of deficiency was issued. No business plans, market studies,
feasibility studies, or corporate minutes were provided to respondent. We cannot tell from the record whether these items existed or were in the possession of petitioner.
Ms. Hamilton notified petitioner's representatives, including Mr. Borawski, during a meeting on June 14, 1993, that she was considering an upward adjustment in petitioner's gross profit spread to 14 percent by lowering its cost of goods sold.
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