Advance Int'l, Inc. v. Comm'r of Internal Revenue, Docket Nos. 7749-87
| Decision Date | 06 September 1988 |
| Docket Number | 7750-87.,Docket Nos. 7749-87 |
| Citation | 91 T.C. 445,91 T.C. No. 34 |
| Parties | ADVANCE INTERNATIONAL, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentADVANCE MACHINE COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Beth L. Williams, for the respondent.
Respondent issued statutory notices of deficiencies to petitioners 1 Advance Machine Company (Machine) and Advance International, Inc. (International) on December 29, 1986. In the statutory notices respondent determined that International did not qualify as a domestic international sales corporation (DISC) during its fiscal years 1980, 1981, and 1982. Respondent determined the following deficiencies (which result from taxing International's DISC income to both entities in the alternative):
+--------------------------------------------+
¦MACHINE ¦
+--------------------------------------------¦
¦Years ending Dec. 31—¦Deficiencies¦Additions¦
+---------------------+------------+---------¦
¦1979 ¦$466,358 ¦--- ¦
+---------------------+------------+---------¦
¦1980 ¦346,802 ¦--- ¦
+---------------------+------------+---------¦
¦1981 ¦591,550 ¦--- ¦
+--------------------------------------------¦
¦INTERNATIONAL ¦
+--------------------------------------------¦
¦Years ending Jan. 31—¦Deficiencies¦Additions¦
+---------------------+------------+---------¦
¦1980 ¦$559,731 ¦--- ¦
+---------------------+------------+---------¦
¦1981 ¦713,941 ¦--- ¦
+---------------------+------------+---------¦
¦1982 ¦696,938 ¦--- ¦
+--------------------------------------------+
The parties have since stipulated that International qualified as a DISC for its fiscal year ended January 31, 1982. After concessions the only issue remaining is whether, for the fiscal years ended January 31, 1980, and January 31, 1981, the adjusted basis of International's qualified export assets equalled or exceeded 95 percent of the adjusted basis of all of its assets. See sec. 992(a)(1)(B) 2; sec. 1.992-1(c), Income Tax Regs. The resolution of this issue depends upon whether the debit balance in International's Intercompany Clearing Account at the end of each of the years in issue is export property such that the amount in the account should be included in International's qualified export assets.
Some of the facts have been stipulated and are so found. Machine and International are United States corporations whose principal places of business are, and were at the time the petitions in these cases were filed, in Spring Park, Minnesota. Machine was incorporated in 1926 and International was incorporated in 1972. Machine owned 100 percent of International's issued and outstanding stock at all times from International's incorporation through the years in issue.
Machine is engaged in the business of manufacturing and selling floor cleaning, scrubbing, and polishing machinery, vacuum cleaners for commercial and industrial use, floor maintenance equipment, and related accessories. These products are sold domestically and exported.
Machine sold its products in the export market for approximately 10 years before availing itself of the advantages of the DISC provisions and forming International. Commencing with its taxable year ending January 31, 1973, and during the years in issue, International was responsible for, and caused Machine's export products to be sold and distributed outside the United States. Machine manufactured all of the export products generating the receipts reported on International's DISC returns, and all of International's sales consisted entirely of export property manufactured or purchased by Machine. During each year in issue 95 percent or more of International's gross receipts, as defined in section 993(f), met the definition of qualified export receipts set forth in section 993(a)(1)(A).
International consistently operated as a buy-sell DISC during the years in issue and was a fully operational corporation, maintaining its own staff of employees, and hiring distributors who were responsible for soliciting, processing, and making sales of export products in the foreign market. As a buy-sell DISC International acted as purchaser and reseller of Machine's export products. International computed its DISC taxable income in an amount equal to 50 percent of the combined taxable income of International and Machine plus 10 percent of International's export promotion expenses attributable to export receipts.
Sales transactions were accounted for in International's general ledger accounts. When a sale occurred, International debited Trade Accounts Receivable in the amount of the export sales, at the aggregate invoiced sales price for the month and credited its Sales Accounts in the same amount. To record collection of accounts receivable from export customers, International debited its Cash in Bank accounts for the amount of the cash received from export customers and credited Trade Accounts Receivable for the same amount.
Periodic cash transfers to Machine and charges for cost of goods sold were also recorded in the general ledger accounts. To record intercompany transfers of funds, International debited the Intercompany Clearing Account with Machine in the amount of the cash transfer to Machine. 3 To account for the cost of sales International debited its Cost of Sales accounts in the amount of the standard costs incurred by Machine attributable to export sales, including variance allocation, and credited the Intercompany Clearing Account with the standard cost of sales attributable to export sales, making adjustments to record variances to standard costs on a monthly basis.
The balance in the Intercompany Clearing Account never reached zero during the years in issue; amounts were routinely transferred to Machine 4 and costs of goods sold were continuously being credited to the account, along with the monthly adjustments to the account. When International completed its DISC returns for the years in issue, it listed the debit balance of the account as of the end of each fiscal year as a qualified export asset. 5 In his statutory notice respondent determined that the balance in the Intercompany Clearing Account did not represent a qualified export asset. Respondent maintains that the debit balance in the account at the year end reflects an excess of funds transferred to Machine above the transfer price or cost of goods sold. Respondent contends that although the debit balance in the account reflects an account receivable, the receivable cannot be a qualified export asset within the meaning of section 993(b) and (c).
Petitioners claim that the account balance represents a beneficial interest in Machine's export inventory to which they are entitled, and that therefore the account balance should be included in International's qualified export assets. Petitioners maintain that the course of operations between the two corporations and the status of orders and inventory on hand at year end and shortly thereafter establish that the account represents this beneficial interest.
Machine had business locations in Spring Park and Plymouth, Minnesota, during the years in issue. The Spring Park facility was used as its manufacturing plant, where fabrication took place and raw materials were stored. The Plymouth facility was used as Machine's assembly, packaging, warehouse and shipment plant, and was sometimes referred to as Machine's distribution center.
Machine produced approximately 200 different models of 115 volt, 230 volt, battery and industrial machines during the years in issue. The specific models were divided into approximately ten ‘families‘ such as floor machines, vacuums, convertamatics and automatic scrubbers. All of the 230 volt models, approximately 20 percent of the battery convertamatics and 25-30 percent of the industrial machines, were produced for export.
The distribution center in Plymouth consisted of two rectangular-shaped buildings connected by a link, forming an ‘H.‘ 6 All types of machines for both domestic and international markets were assembled in the building to the left of the link. After assembly was completed machines were transmitted across the link to the other building which was and is the storage area of the distribution center. The storage area is divided by columns into storage bays which are 33 feet wide, each bay containing approximately 5,000 square feet of floor space.
The distribution center manager and his assistant determined where the finished products would be stored in the Plymouth facility. The 230 volt machines were always stored in the international product storage bays. These two bays were in the southern section of the right side of the storage area. The international storage bays were separated by a rigid wall from the domestic storage area. Battery and industrial machines, which could be sold in either the domestic or international market, were stored in two locations in the distribution center. Those which were to be sold in the domestic market were stored in the general warehouse portion of the storage area, and those which were to be sold in the export market were stored in the international storage bays.
The determination of which battery and industrial machines were to be stored in the international bays was made after an examination of the weekly order reports for international customers. The order reports stated, by product code and customer order, the total current outstanding orders. The staging ledger, showing the total number and type of battery and industrial machines stored in the general...
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