Procter & Gamble Co. and Subsidiaries v. U.S.
| Decision Date | 25 June 2010 |
| Docket Number | Case No. 1:08-cv-00608 |
| Citation | 733 F.Supp.2d 857,106 A.F.T.R.2d 2010 |
| Court | U.S. District Court — Southern District of Ohio |
| Parties | The PROCTER & GAMBLE COMPANY AND SUBSIDIARIES, Plaintiff, v. UNITED STATES of America, Defendant. |
Daniel H. Schlueter, Kent L. Jones, Victoria A. O'Connor, Sutherland Asbill & Brennan LLP, Washington, DC, Mark Alan Vanderlaan, Cincinnati, OH, for Plaintiff.
Christine Hooks, Lisa L. Bellamy, Robert J. Kovacev, Karen A. Smith, Washington, DC, Brian Richard Harris, Julie Ciamporcero Avetta, U.S. Department of Justice, Washington, DC, for Defendant.
ORDER GRANTING PLAINTIFF'S MOTION FOR PARTIAL SUMMARY JUDGMENT RE THE "GROSS RECEIPTS" RESEARCH CREDIT ISSUE (Doc. 43) AND DENYING DEFENDANT'S CROSS MOTION FOR PARTIAL SUMMARY JUDGMENT (Doc. 66)
This civil action is before the Court on the parties' cross motions for partial summary judgment concerning the "Gross Receipts" research credit issue (Docs. 43, 66) and the parties' responsive memoranda (Docs. 45, 47, and 95).
Ultimately, Defendant United States of America determined that Plaintiff Procter & Gamble Company and Subsidiaries ("P & G") improperly excluded receipts from intercompany transfers with the foreign members of its controlled group when determining "Gross Receipts" for the purposes of calculating its research tax credit. That is, during its audit of P & G's 2001-2005 years, The Internal Revenue Service ("IRS") issued a notice of proposed adjustment which reversed its prior position that all receipts from intercompany transfers be excluded. The IRS stated that intercompany transactions with foreign members of controlled groups should no longer be excluded from Gross Receipts, and that P & G's computations were incorrect. P & G paid the resulting additional tax to the IRS, and then commenced this civil action seeking, inter alia, a refund of those amounts.
P & G alleges that its research tax credit computation was proper because purely intercompany transactions are properly disregarded under 26 U.S.C. § 41(f) of the Internal Revenue Code and Treasury Regulation 26 C.F.R. § 1.41-6T(i). P & G claims that the IRS' subsequent decision to reverse its prior position contradicts the statute and the IRS' own regulations, and is contrary to the intent of Congress in enacting the research credit provisions.
Defendant alleges that 26 U.S.C. § 41(c)(6) specifically addresses what is to be included in Gross Receipts, and that this specific provision, rather than § 41(f), controls. Defendant claims that the plain language, legislative history, and case law regarding § 41(c)(6) establishes that, with respect to foreign members of the controlled group, the only exclusions from Gross Receipts are receipts from a foreign subsidiary corporation that are not "effectively connected to a trade or business in the United States...." Defendant alleges that international intercompany transfers must therefore be included in Gross Receipts.
The sole issue that the cross motions seek to resolve is a legal one, i.e., whether a taxpayer must include the results of its intercompany transactions within its "Gross Receipts" for the purposes of determining the amount of its research credit under 26 U.S.C. § 41.
1. P & G is the common parent of an affiliated group of corporations that is engaged in the manufacture and sale of consumer products in the United States and throughout the world, under a variety of well-known brand names, such as Ivory, Tide. Bounty, Pantene, Pampers, Pringles, Charmin, Crest, and Iams. (Declaration of Deborah Moore ¶ 2).2
2. P & G's business operations are divided among numerous separate subsidiary corporations, which perform different functions within P & G's business hierarchy. (Moore Decl. ¶ 3.) As part of P & G's internal business operations, these subsidiary corporations regularly engage in intercompany transactions with one another. ( Id.) For example, one of P & G's subsidiaries during the years at issue in this case was P & G Distributing, Inc., which was a Delaware corporation wholly owned by P & G. ( Id. ¶ 4.) The primary business activity of P & G Distributing was the sale and distribution of P & G's products. (Id.) To conduct that business, P & G Distributing regularly purchased P & G products at a standard intercompany price from other P & G subsidiaries whose business was to manufacture those products.3 ( Id.) P & G Distributing then re-sold the products it had purchased from P & G's manufacturing subsidiaries to third-party customers ( e.g., retail stores that sell to consumers) or to other domestic and foreign subsidiaries owned by P & G in further intercompany transactions. ( Id.)
3. During the years at issue in this case, in addition to P & G Distributing, P & G owned many additional subsidiaries which were engaged in the manufacture and sale of specific P & G products and which were members of P & G's "controlled group of corporations," as that term is defined in 26 U.S.C. § 41(f)(5).4 (Moore Decl. ¶ 5.) These subsidiaries regularly engaged in intercompany transactions with one another as part of P & G's business operations. ( Id.)
4. During the tax years at issue in this case, P & G engaged in extensive research activities related to the development and improvement of new technologies and products. (Moore Decl. ¶ 6.) As a result of these activities, P & G claimed research tax credits under 26 U.S.C. § 41(a) on its tax returns for the expenses incurred in connection with those research activities. ( Id.)
5. In calculating its research credit, P & G treated all members of its "controlled group of corporations" as a single taxpayer, as required by 26 U.S.C. § 41(f)(1). (Moore Decl. ¶ 7.) Consistent with this requirement, P & G aggregated its Research Expenses and Gross Receipts for the controlled group as a whole and excluded intercompany transactions when calculating the credit. ( Id.) This was the same methodology that had been accepted by the IRS in its prior audits of P & G's tax returns for prior tax years. ( Id.)
6. In 2005, during the course of its audit of the tax years at issue in this case, the IRS requested documents from P & G showing how it determined its Gross Receipts in computing the credit. After receiving the requested documents from P & G, the IRS issued a written determination (dated August 29, 2005), in which the IRS adopted P & G's computations as correct. ( In doing so, the IRS concluded that P & G had correctly excluded intercompany transactions in determining its Gross Receipts, including in particular those intercompany transactions with foreign members of its "controlled group." The IRS determination provided in relevant part as follows:
(Moore Decl. Exh. C, at 3 (capitalization emphasis in original)).5
7. On February 14, 2006, after the IRS audit team had made its determination to allow P & G's computation of Gross Receipts and Base Amount, the IRS Office of Chief Counsel issued a new Chief Counsel Advice, which revised the agency's position on Gross Receipts. See CCA 200620023, 2006 WL 1370917 (Feb. 14, 2006). The 2006 Chief Counsel Advice now took the position that a "controlled group" should "only disregard generally intra-group transfers with respect to research expenditures, not gross receipts." Id. However, the 2006 Chief Counsel Advice applies this new rule only in the context of "receipts from ... foreign subsidiaries," not to receipts from domestic subsidiaries. Id. Also, for reasons that are not explained, the 2006 Chief Counsel Advice does not cite, or otherwise acknowledge, the 2002 Chief Counsel Advice-CCA 200233011 (2002 WL 1883657)-which the IRS' audit team had relied upon to conclude that "the taxpayer should EXCLUDE sales to majority owned foreign subsidiaries" in calculating its Gross Receipts. (Moore Decl. Exh. C, at 3.)
8. On January 16, 2007, following the issuance of the 2006 Chief Counsel Advice, the IRS audit team auditing P & G's returns issued a new notice of proposed adjustment, in which it reversed its prior determination on the basis stated in the 2006 Chief Counsel Advice. (Moore Decl. ¶ 12 & Exh. D.) That is, the IRS now claimed that intercompany transactions with foreign members of its controlledgroup should no longer be "EXCLUDE[D]" from Gross Receipts, and that P & G's computation of Gross Receipts and its Base Amount was therefore incorrect. ( Id.)
9. Thus, for the 2001-2005 tax years, the IRS recomputed P & G's average annual Gross Receipts by adding foreign intercompany sales to P & G's Gross Receipts as follows:
Image 1 (5.03" X 3.29") Available for Offline Print
(Moore Decl. ¶ 13 & Exh. D at ADM-24-0161 to ADM-24-0165.)
10. The IRS' recalculation, however, left unchanged P & G's treatment of intercompany sales to its domestic subsidiaries. (Moore Decl. ¶ 14). Receipts from domestic intercompany sales continued to be excluded from P & G's Gross Receipts. ( Id.)
11. Based on its revised determination of P & G's Gross Receipts, the IRS recomputed P & G's Base Amount for the tax years at issue. (Moore Decl. ¶ 15). Because the Base Amount increases as Gross Receipts increase, the higher Gross Receipts amounts computed by...
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...on the decision of the District Court for the Southern District of Ohio in Procter & Gamble Co. v. United States, No. 1:08-cv-00608 (TSB), 2010 WL 2925099, 106 A.F.T.R.2d 2010-5311 (S.D. Ohio July 6, 2010). In that case, the plaintiff-taxpayer, Procter & Gamble Co. ("Procter & Gamble") rece......