Brown Grp., Inc. v. Comm'r of Internal Revenue

• Decision Date: 25 January 1995
• Docket Number: No. 104–92.,104–92.
• Citation: 104 T.C. No. 5,104 T.C. 105
• Parties: BROWN GROUP, INC. AND SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.*
• Court: U.S. Tax Court

104 T.C. 105

104 T.C. No. 5

BROWN GROUP, INC. AND SUBSIDIARIES, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.*

No. 104–92.

United States Tax Court.

Jan. 25, 1995.

Harold G. Blatt, Juan D. Keller, and Philip B. Wright, St. Louis, MO, for petitioner.

James A. Kutten and Richard A. Witkowski, St. Louis, MO, for respondent.

Petitioner is the common parent corporation of an affiliated group of corporations making a consolidated return of income (the affiliated group). The only issue in dispute is whether a member of the affiliated group's share of partnership income from a foreign partnership is subpart F income, includable in the gross income of the member under sec. 951(a). Held: We hold that such income is subpart F income includable in the gross income of the member under sec. 951(a).

HALPERN, Judge:

Petitioner is the common parent corporation of an affiliated group of corporations making a consolidated return of income (the affiliated group). Respondent determined a deficiency of $388,992.85 in the income tax liability of the affiliated group for its taxable year ended November 1, 1986.¹

The only issue in dispute is whether Brown Cayman Ltd.'s (Brown Cayman's) share of partnership income from Brinco, a Cayman Islands partnership, is subpart F income, includable in the gross income of a member of the affiliated group under section 951(a). We hold that it is.

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

A trial was held on March 9, 1993. Petitioner called no witnesses. Respondent called one: Theodore Presti. The parties had stipulated certain facts, however, and the facts stipulated are so found. The stipulation of facts and attached exhibits is incorporated herein by this reference. The following summarizes the facts relied on by us in reaching our decision.

Petitioner Brown Group, Inc. (sometimes Brown Group), is a New York corporation. At the time the petition herein was filed, petitioner's principal place of business was in St. Louis, Missouri. The following diagram facilitates an understanding of the relationships of the parties involved:

Image 1 (6.05" X 4.68") Available for Offline Print Throughout 1985 and 1986, Brown Group had divisions that sold footwear at the retail and wholesale levels, manufactured footwear, and imported footwear. Brown Group manufactured footwear in the United States and imported footwear from, among other countries, Brazil.

Brown Group International (International), a Delaware corporation, was incorporated in 1985, as a wholly owned subsidiary of Brown Group. Throughout 1985 and 1986, International was a United States shareholder of Brown Cayman within the meaning of section 951(b).

Brown Cayman, a Cayman Islands corporation, was incorporated in 1985. Brown Cayman was a controlled foreign corporation within the meaning of section 957(a) at all times relevant to this case.

T.P. Cayman, Ltd. (T.P. Cayman), a Cayman Islands corporation, was incorporated in March 1985.

Pidge, Inc. is a Missouri corporation; the date of its incorporation is not contained in the record.

Brinco, a partnership within the meaning of section 7701, and the regulations thereunder, was formed in the Cayman Islands in March 1985. The partners of Brinco, and their percentage interests in the net profits and losses of Brinco, were Brown Cayman, 88 percent, T.P. Cayman, 10 percent, and an individual, Delcio Birck (Birck), 2 percent.

Prior to the formation of Brinco, Brown Group utilized independent agents to purchase footwear manufactured in Brazil. At that time, Birck, a Brazilian citizen, and Presti, a United States citizen, were employed by a company, Michelle Manard, which purchased footwear manufactured in Brazil on behalf of Brown Group and others. Michelle Manard “officially” charged Brown Group a 7–percent commission, although, occasionally, that rate was greater. Brinco was formed, among other reasons, to attract Presti and Birck to source Brazilian footwear exclusively for the Brown Group companies and to consolidate Brown Group's Brazilian buying power. Brinco was structured as a partnership, among other reasons, because: (1) Presti's salary requirements could not be satisfied within Brown Group's existing payroll structure, (2) it allowed Presti and Birck to have some entrepreneurial interest in Brinco's operations, and (3) it permitted the partners to avoid Brazilian currency controls and currency fluctuations.

During 1985 and 1986, Brinco acted as purchasing agent for International with respect to footwear manufactured in Brazil. The footwear so imported was sold primarily in the United States.

Presti was the managing partner of Brinco. As such, he was responsible for the design, manufacture, and quality control of the footwear. He also supervised Brinco's operations within Brazil.

The Brown Group companies paid Brinco a 10–percent commission for acting as their purchasing agent for footwear manufactured in Brazil. The commission was based on the purchase price of the footwear. Brinco's 1985 commission income for acting as purchasing agent for the Brown Group companies was $1,119,970. The Brown Group companies included the commissions paid to Brinco in their costs of goods sold.

Pursuant to negotiations among the Brinco partners, because of the uncertainty of first year profits, for the 7–month period ending November 2, 1985, T.P. Cayman received guaranteed payments totaling $151,662 ($21,666 a month for 7 months), instead of its share of partnership profits called for in the Brinco partnership agreement. After making guaranteed payments to T.P. Cayman, Brinco's partnership net earnings for 1985 totaled $917,465, which were distributed as follows:

+---------------------------------+
                ¦¦Brown Cayman¦98 percent¦$897,281¦
                ++------------+----------+--------¦
                ¦¦Birck       ¦2 percent ¦20,184  ¦
                +---------------------------------+
                

In 1986, T.P. Cayman received its share of partnership profits as called for in the Brinco partnership agreement (and no guaranteed payments).

Brinco was dissolved on October 31, 1987. At that time, Presti became executive vice president of International and Birck, as an independent agent, continued to source footwear for the Brown Group companies on a commission basis.

Respondent determined that Brown Cayman's distributive share of Brinco's earnings is foreign base company sales income, includable as subpart F income in the gross income of International.

OPINION

I. Introduction

For all relevant periods, the parties have stipulated that (1) Brown Cayman was a “controlled foreign corporation” (CFC) within the meaning of section 957(a) and (2) International was a “United States shareholder” of Brown Cayman within the meaning of section 951(b). Accordingly, International must include in its gross income its pro rata share (100 percent) of any “subpart F income” of Brown Cayman. See sec. 951(a). Subpart F income is defined in section 952 to include an item called “foreign base company income”. Sec. 951(a)(2). Foreign base company income, in turn, is defined in section 954(a) to include “foreign base company sales income”. Sec. 954(a)(2). Foreign base company sales income includes, among other things: “income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with * * * the purchase of personal property from any person on behalf of a related person” where the goods are both produced and sold for use outside the country in which the CFC is incorporated. Sec. 954(d)(1). The term “related person” is defined in section 954(d)(3). It is clear that International was a related person with regard to Brown Cayman. See sec. 954(d)(3) (“such person is a corporation which controls * * * the controlled foreign corporation”). It also is clear that Brinco earned commission income by arranging for the purchase of footwear by International.² Brinco was a partnership of which Brown Cayman was a partner. Brown Cayman was entitled to share in the income of Brinco. Pursuant to section 702, Brown Cayman was required to take into account its distributive share of that income.³ The narrow question we must answer is whether Brown Cayman had income “(whether in the form of profits, commissions, fees, or otherwise) derived in connection with * * * the purchase of personal property from any person on behalf of a related person”. See sec. 954(d)(1). We believe that it did.

II. Arguments of the PartiesA. Petitioner's Argument

Petitioner argues as follows: Under section 954(d)(3), as in effect for the year in issue, Brinco was not a related person with regard to Brown Cayman or International. Absent such a relationship, Brown Cayman's distributive share of Brinco's income cannot be subpart F income with respect to Brown Cayman or International. Alternatively, the character of the income in question is determined at the partnership (Brinco) level, by treating Brinco as a separate entity. Consequently, the income in question is that of Brinco, not Brown Cayman. Thus, the income cannot be foreign base company sales income of Brown Cayman. B. Respondent's Argument

Respondent agrees that, under section 954(d)(3), as in effect for the year in issue, Brinco was not a related person with regard to Brown Cayman or International. Respondent's argument is as follows: The aggregate theory of partnerships should apply in this case because that theory furthers the purposes of subpart F. Under the aggregate theory, Brown Cayman's distributive share of Brinco's income must be treated as foreign base company sales income and, consequently, subpart F income. International, the United States shareholder of Brown Cayman, must include its pro rata share (100 percent) of Brown Cayman's subpart F income in its gross income under section 951(a). Respondent has not argued that Brinco is a sham.

III. AnalysisA. I...