Ciba-Geigy Corp. v. Revenue, Docket No. 2831-78.
| Decision Date | 01 August 1985 |
| Docket Number | Docket No. 2831-78. |
| Citation | 85 T.C. 172,85 T.C. No. 11 |
| Parties | CIBA-GEIGY CORPORATION, Petitioner v. INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
G, a Swiss corporation, granted to P, its wholly-owned United States subsidiary, an exclusive license to manufacture, formulate and sell certain triazine herbicides in the United States. In return, P agreed to pay G a royalty equal to 10 percent of net sales.
HELD, R abused his discretion under section 482 when he determined that a 10 percent royalty rate did not constitute an arm's-length consideration for the license agreements in issue, subject, however, to a reasonable allocation for certain services performed by petitioner. Section 1.482-2(d), Income Tax Regs., applied.
WAYNE E. CHAPMAN, RICHARD L. HOFFMAN, DOUGLAS R. COX, STEPHEN
STANLEY J. GOLDBERG, DAVID M. BRANDES and RICHARD M. DUNCAN, for the respondent.
Respondent determined deficiencies in petitioner's income taxes and liabilities for withholding of income taxes at the source in the amounts and for the taxable years, as follows:
The foregoing deficiencies and liabilities reflect amounts determined in a deficiency notice, a statutory notice of liability and an amended answer, as follows: In respondent's statutory notice of deficiency, dated December 23, 1977, deficiencies were determined in petitioner's income taxes for the taxable years and in the amounts, as follows:
+-------------------------------------+
¦TYE ¦Income tax deficiencies¦
+-------------+-----------------------¦
¦Dec. 31, 1965¦$3,345,184.80 ¦
+-------------+-----------------------¦
¦Dec. 30, 1966¦4,147,053.36 ¦
+-------------+-----------------------¦
¦Dec. 29, 1967¦6,331,047.37 ¦
+-------------+-----------------------¦
¦Jan. 3, 1969 ¦8,071,319.51 ¦
+-------------+-----------------------¦
¦Dec. 26, 1969¦17,844,438.00 ¦
+-------------------------------------+
Respondent also issued a statutory notice of liability for withholding of income taxes at the source on December 23, 1977, as follows:
+--------------------------------+
¦ ¦Liabilities for ¦
+-------------+------------------¦
¦ ¦withholding income¦
+-------------+------------------¦
¦TYE ¦taxes at source ¦
+-------------+------------------¦
¦Dec. 31, 1965¦$348,457 ¦
+-------------+------------------¦
¦Dec. 31, 1966¦432,032 ¦
+-------------+------------------¦
¦Dec. 31, 1967¦$659,484 ¦
+-------------+------------------¦
¦Dec. 31, 1968¦764,330 ¦
+-------------+------------------¦
¦Dec. 31, 1969¦881,073 ¦
+--------------------------------+
Respondent's statutory notice of deficiency disallowed a portion of the agricultural chemical royalties paid by petitioner to its parent company. Respondent reduced petitioner's claimed 10 percent royalty rate to a six percent royalty rate, which four percent reduction resulted in the disallowance of the following amounts of royalties:
+-------------------------------------+
¦ ¦Amounts ¦
+-------------+-----------------------¦
¦TYE ¦of royalties disallowed¦
+-------------+-----------------------¦
¦Dec. 31, 1965¦$1,654,712.54 ¦
+-------------+-----------------------¦
¦Dec. 30, 1966¦2,433,541.00 ¦
+-------------+-----------------------¦
¦Dec. 29, 1967¦3,804,337.08 ¦
+-------------+-----------------------¦
¦Jan. 3, 1969 ¦5,343,224.60 ¦
+-------------+-----------------------¦
¦Dec. 26, 1969¦7,417,190.55 ¦
+-------------+-----------------------¦
¦Total ¦20,653,005.77 ¦
+-------------------------------------+
In an Amended Answer, respondent sought to disallow the previously allowed and remaining royalties paid by petitioner to its parent company. As set forth in the Amended Answer on November 30, 1982, the proposed additional disallowances were as follows:
+-------------------------------------+
¦ ¦Additional amounts ¦
+-------------+-----------------------¦
¦TYE ¦of royalties disallowed¦
+-------------+-----------------------¦
¦Dec. 31, 1965¦$2,399,826.98 ¦
+-------------+-----------------------¦
¦Dec. 30, 1966¦3,587,711.89 ¦
+-------------+-----------------------¦
¦Dec. 29, 1967¦5,616,801.34 ¦
+-------------+-----------------------¦
¦Jan. 3, 1969 ¦7,841,833.13 ¦
+-------------+-----------------------¦
¦Dec. 26, 1969¦10,687,337.52 ¦
+-------------+-----------------------¦
¦Total ¦30,133,510.86 ¦
+-------------------------------------+
Based on these proposed additional disallowances respondent asserted increased deficiencies in petitioner's income taxes as follows:
+-------------------------------------+
¦TYE ¦Amounts of deficiencies¦
+-------------+-----------------------¦
¦Dec. 31, 1965¦$1,151,917.15 ¦
+-------------+-----------------------¦
¦Dec. 30, 1966¦1,722,101.70 ¦
+-------------+-----------------------¦
¦Dec. 29, 1967¦$2,696,064.64 ¦
+-------------+-----------------------¦
¦Jan. 3, 1969 ¦4,140,487.95 ¦
+-------------+-----------------------¦
¦Dec. 26, 1969¦5,642,914.55 ¦
+-------------------------------------+
Petitioner asserted in its petition a set-off claim against respondent's proposed section 482 allocation. Petitioner asserts this claim on the grounds that an unrelated third party dealing at arm's length with petitioner's Swiss parent corporation would have been willing to pay a 15 percent royalty rate for the triazine licensing rights involved in this case. Based on this proposition, petitioner alleges entitlement to an increased annual deduction for additional royalties payable to its parent. Petitioner calculated the amounts of these deductions as follows:
+-------------------------------+
¦ ¦Amounts asserted ¦
+-------------+-----------------¦
¦TYE ¦to be deductible ¦
+-------------+-----------------¦
¦Dec. 31, 1965¦$2,068,390 ¦
+-------------+-----------------¦
¦Dec. 30, 1966¦3,041,925 ¦
+-------------+-----------------¦
¦Dec. 29, 1967¦4,755,451 ¦
+-------------+-----------------¦
¦Jan. 3, 1969 ¦6,679,061 ¦
+-------------+-----------------¦
¦Dec. 26, 1969¦9,271,487 ¦
+-------------+-----------------¦
¦Total ¦25,816,314 ¦
+-------------------------------+
After concessions, the issues for decision are:
1. Whether royalty payments made by petitioner to its Swiss parent corporation in exchange for licensing rights to make, use and sell triazine herbicides in the United States were excessive under the arm's length standard of section 482 1 and therefore subject to reallocation; and
2. Whether royalty payments disallowed by respondent constitute dividends subject to the section 1442(a) five percent withholding of income tax at the source.
Some of the facts have been stipulated. The stipulations and their attached exhibits are incorporated herein by this reference.
Petitioner, Ciba-Geigy Corporation (Ardsley or petitioner), a New York corporation, had its principal place of business in Ardsley, New York, at the time of filing its petition in this case. Petitioner is an accrual basis taxpayer. For all taxable years in issue petitioner utilized a 52-53 week year as its taxable year except for the year 1965 when it used a calendar year.
The Swiss parent company of Ardsley was founded in Basle, Switzerland, in 1758 as a family operated trading company specializing in imported dyestuffs. By the mid-1860s the company commenced production of synthetic aniline dyes. In 1862 it built a factory in Basle to assure volume production capability of the synthetic aniline dyes. Beginning in the late 1860s, the parent company established an experimental chemical laboratory at its Basle facility; it has maintained this laboratory to the present time. Prior to 1870, the parent company had built a network of Central and Western European sales agents and representatives to distribute its products; in the 1870s it expanded this network to include various European countries, India, the Far East and the United States.
On January 1, 1901, the original parent company was reorganized from a family operation into a joint stock company, and in 1914 it adopted the name of J. R. Geigy S.A. In 1903, the original Swiss parent company organized The Geigy Aniline and Extract Company (GAE) as a wholly-owned subsidiary to market and sell its products in the United States. In 1909, Geigy-ter-Meer Company, later Geigy Company, Inc., was organized in New York to...
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