United States Gypsum Company v. United States, 62 C 672.

CourtUnited States District Courts. 7th Circuit. United States District Court (Northern District of Illinois)
Citation304 F. Supp. 627
Docket NumberNo. 62 C 672.,62 C 672.
PartiesUNITED STATES GYPSUM COMPANY and United States Gypsum Export Company, Plaintiffs, v. UNITED STATES of America, Defendant.
Decision Date11 June 1969

COPYRIGHT MATERIAL OMITTED

Charles M. Price, William D. McFarland, Robert M. Gunn, Chicago, Ill., for plaintiffs, Spray, Price, Hough & Cushman, Chicago, Ill., of counsel.

Mitchell Rogovin, Asst. Atty. Gen., David A. Wilson, Jr., Donald R. Anderson, Steven Shapiro, Richard J. Sideman, Attys., Dept. of Justice, Washington, D. C., Thomas A. Foran, U. S. Atty., Chicago, Ill., for defendant, United States.

FINDINGS OF FACT, CONCLUSIONS OF LAW, MEMORANDUM AND ORDER

CAMPBELL, Chief Judge.

This is a consolidated action and involves three suits brought by the United States Gypsum Company ("USG") and its wholly owned subsidiary, the United States Gypsum Export Company ("Export") for refunds for federal income taxes paid by plaintiffs. The cases involve the tax liability of USG for the years 1954 and 1955 and again for 1957 and 1958, and the taxes of Export for the years 1957 and 1958. The defendant, ("government") not only denied all grounds for refund, but also claimed certain offsets as affirmative defenses. The basis for the alleged offsets is that USG paid one of its wholly owned subsidiaries excessive amounts for transporting its products and that it paid another subsidiary, Export, excessive amounts for crude gypsum rock, and undercharged it for finished products intended for resale by Export.

The issues are numerous and complex. After consolidation of the cases and extensive pre-trial discussions between the court and counsel, it was determined and agreed that this was what is traditionally referred to as the "Protracted Case", a case which should be tried under the special procedure recommended by the Judicial Conference of the United States as set forth in the Handbook of Recommended Procedures For Protracted Cases (currently titled Manual for Complex and Multidistrict Litigation). Following the recommended procedures as set forth in the Manual, counsel for both parties prepared and agreed to a rather extensive stipulation of facts thus enabling all of us to define just wherein genuine disagreement existed. I commend all counsel for their efforts in this regard and for the cooperative spirit in which they labored. These many and extended conferences, some with the court but many between counsel and their principals, have resulted in the settlement of possibly the most complex and difficult issue in this litigation. That issue, generally referred to as the "depletion issue", involved USG's deductions during all the years in question for depletion of its mineral deposits. Again, I compliment counsel for their cooperation and efforts in reaching a fair and just settlement on that issue and removing that most difficult question from the court's consideration.

On the remaining issues, extensive stipulations were filed by the parties and where no agreement could be reached the court heard the testimony and received various exhibits into evidence. This testimony and the many exhibits shall be referred to in some detail herein. With the elimination of the depletion issue there remained and is now before me basically four broad and generally unrelated issues. I shall briefly summarize them.

The first issue concerns the reasonableness of charges paid by USG to Panama Gypsum Inc. ("Panama"), a wholly owned subsidiary of USG organized under the laws of the Republic of Panama, for transporting by ship crude gypsum rock from gypsum mines in Nova Scotia and Jamaica to USG's plants in the United States. The Nova Scotia mines are owned and operated by Little Narrows Gypsum Co. Ltd. ("Narrows") a Canadian Company wholly owned by USG. The Jamaica mines are owned and operated by Jamaica Gypsum Ltd. ("Jamaica") also a subsidiary of USG, organized under the laws of Jamaica, British West Indies. The question presented is basically whether the charges were excessive, and if so, was the excess properly reallocated to USG pursuant to the provisions of section 482 of the Internal Revenue Code (26 U.S.C. § 482) in order clearly to reflect its income for federal income tax purposes.

The second issue involves the operations and earnings of United States Gypsum Export Co. Export purchased rock from Canadian Gypsum ("Canadian") another wholly owned subsidiary, organized under the laws of the Dominion of Canada, and from Narrows and Jamaica which it in turn sold to USG. It also sold finished gypsum products which it purchased from USG. This issue has generally been referred to as the "Export issue" and presents the questions: (a) Whether Export was a Western Hemisphere Trade Corporation under the Internal Revenue Code (26 U.S.C. § 921-922); and (b) Whether the income of Export earned from the sale of rock to USG and the sale of manufactured products purchased from USG should properly be reallocated to USG again under section 482 (26 U.S.C. § 482) in order to clearly reflect the income of USG for federal income tax purposes.

Less complicated factually, if not legally, are the two remaining issues which counsel and the court have come to refer to as the "stock split issue" and the "patent infringement issue". The first relates to the deductibility as ordinary and necessary business expense of certain amounts paid for legal and registration fees and for stock certificates pursuant to a stock split and whether certain of the said amounts paid in connection with an earlier reorganization and subsequent stock dividends are deductible by USG in 1955 as an ordinary loss deduction (26 U.S.C. § 165). The patent infringement issue involves the tax consequences of an amount received by USG as a result of certain patent litigation.

Resolution of all of the above issues requires detailed discussion of the far reaching and complex operations of the United States Gypsum domain. Additional facts, where necessary, will be set forth in the discussion of the individual issues.

THE SHIPPING ISSUE

This issue involves USG and the tax years 1954, 1955, 1957 and 1958. USG's tax returns for these years were audited by the Internal Revenue Service and certain deficiencies were assessed. USG paid these deficiencies and then made a claim and subsequently filed suit for refund. At this point no questions had been raised by the Internal Revenue Service with regard to the amounts paid by USG for shipping services to Panama and none of the deficiencies which were assessed involved payments to Panama for shipping services. Panama's returns for the years 1954, 1955, 1957 and 1958 were likewise audited by the Internal Revenue Service (Office of International Operations). In these audits neither the Secretary of the Treasury nor his delegate undertook under Section 482 to distribute a portion or allocate any gross income, deductions, credits or allowances between Panama and USG. In its amended answers to the refund suits filed by USG for the years 1954, 1955, 1957 and 1958, the government first raised the "shipping issue" by then claiming that the amounts paid by USG to Panama for shipping services during the years in question were excessive and that any amounts due in the refund suits should be offset by the amounts of the excessive shipment payments. Authority for the offsets was claimed under sections 61, 162 and 482. (26 U.S.C. §§ 61, 162 and 482). The government now limits its claimed authority to section 482.1

During the trial of the shipping issue the government's trial counsel introduced into evidence a letter dated October 27, 1967 from the Chief Counsel of the Internal Revenue Service to the Assistant Attorney General, Tax Division, Department of Justice, purporting to allocate under section 482, Panama's income, or at least a substantial part thereof, to USG.

The issue, stated simply is whether the shipping charges paid to Panama by USG were unreasonably high or excessive thus authorizing the application of section 482 of the Internal Revenue Code which permits the Secretary to allocate income and deductions where it is necessary to do so clearly to reflect the income of the actual earner. It is basically a codification of the long established principle expressed in Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75 (1940), that income should be taxed to the party who earned it. Or, as recently stated by our Seventh Circuit Court of Appeals: "The goal of the statutory allocation procedure is to insure that controlled taxpayers are placed on a parity with uncontrolled taxpayers." Local Finance Corporation v. Commissioner of Internal Revenue, 407 F.2d 629, 632 (1969). Parenthetically, I should note that USG also questions the authority of the government to invoke the provisions of section 482 at this time and in the manner of following the procedure it owned subsidiary incorporated under the has in this case. Section 482 of the Internal Revenue Code provides as follows:

"In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses."

Thus the question here is whether it is necessary to allocate Panama's income to USG to prevent evasion of taxes or clearly to reflect the income of USG and Panama. The resolution of this question involves a rather detailed analysis of the USG shipping operation and its history, and the dealings of USG with its subsidiary, Panama. The record...

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