Dhl Corp. and Subsidiaries v. C.I.R.
| Decision Date | 11 April 2002 |
| Docket Number | No. 00-70008.,No. 99-71580.,No. 99-71675.,No. 99-71592.,99-71580.,00-70008.,99-71592.,99-71675. |
| Citation | 285 F.3d 1210 |
| Parties | DHL CORPORATION AND SUBSIDARIES, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. Commissioner of Internal Revenue, Respondent-Appellee. v. DHL Corporation and Subsidiaries, Respondent-Appellee. DHL Corporation and Subsidiaries, Petitioner-Appellant, v. Commissioner of Internal Revenue, Respondent-Appellee. DHL Corporation and Subsidiaries, Respondent-Appellee, v. Commissioner of Internal Revenue, Petitioner-Appellant. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Jr., Howrey Simon Arnold & White, Los Angeles, CA, for petitioner-appellant DHL Corp.
Jonathan S. Cohen, United States Department of Justice, Tax Division, Washington, DC, for respondent-appellee CIR.
On Appeal from a Decision of the United States Tax Court.
Before BEEZER, O'SCANNLAIN and W. FLETCHER, Circuit Judges.
Petitioner DHL Corporation ("DHL") appeals the tax court's affirmance, in part, of the Commissioner of Internal Revenue's assessment of income tax deficiencies and penalties against petitioner for the tax years 1990-1992, based on the Commissioner's power to reallocate income between controlled entities under 26 U.S.C. § 482. Petitioner specifically appeals (1) the § 482 allocation to DHL of additional income arising from DHL's sale to Document Handling Limited, International ("DHLI") of the "DHL" trademark, which the tax court valued at $100 million; (2) the allocation of income to DHL for uncharged royalties from DHLI's use of the "DHL" trademark prior to the sale; and (3) the imposition of penalties under 26 U.S.C. § 6662 triggered by these deficiencies.
The tax court had jurisdiction under 26 U.S.C. §§ 6213-6214, 7442, and this court has jurisdiction under 26 U.S.C. § 7482(a)(1). We reverse the tax court's § 482 allocations to DHL of the value of the foreign trademark rights and unpaid royalties, and reverse the assessment of penalties under § 6662. We otherwise affirm.
The tax court opinion provides a detailed account of the various companies' histories, structures, and dealings. DHL Corp. v. Comm'r, 76 T.C.M. (CCH) 1122 (1998). Here we provide a summary of the relevant facts.
Adrian Dalsey, Larry Hillblom, and Robert Lynn formed DHL Corporation ("DHL"), a package delivery company, in California in 1969. Document Handling Limited, International ("DHLI"), was incorporated in Hong Kong in 1972. Generally, independent local agents conducted the international operations and paid a network fee to DHLI. Middleston, N.V. ("MNV"), incorporated in 1979, owned most of the overseas local operating companies. At trial before the tax court, DHL conceded that, because of overlapping stock ownership, common control existed among DHL, DHLI, and MNV for all relevant times up to December 7, 1990.
From 1972 to 1992, DHL and DHLI/MNV were part of a global network in which DHL handled United States operations exclusively and DHLI/MNV handled foreign operations. DHL delivered DHLI's America-bound shipments, and DHLI delivered DHL's foreign-bound shipments. Until 1987, each company kept for itself the full amount paid by the local customer, and the companies did not exchange fees. Each company also paid for its own advertising expenses in its respective markets. A network steering committee, a specially formed corporation, and other mechanisms coordinated the worldwide DHL network. In 1988, a Worldwide Coordination Center was established in Belgium, with the world operations of the DHL network divided into three regions, each with its own CEO. DHL struggled in the competitive American market, sustaining losses during the 1980s, but DHLI/MNV expanded rapidly and profitably.
In 1974, DHL and DHLI entered into a Memorandum of Oral Agreement ("MOA"), under which DHL licensed the name "DHL" to DHLI for five years, terminable by DHL on 90 days notice. Under the MOA, DHLI would be prohibited from using the "DHL" name for five years after termination. The MOA did not include any provision for the payment of royalties by DHLI to DHL for use of the "DHL" trademark. Through a series of amendments, the MOA was extended through 1990.
In 1977, DHL began the process of registering the "DHL" trademark in the United States. DHLI commissioned the first "DHL" logo, which was then used worldwide. Beginning in 1983, DHLI incurred the expenses of registering the "DHL" trademark under DHLI's name in various foreign countries.
On December 7, 1990, DHL and DHLI entered into a new agreement. Under its terms, DHL had the exclusive right to use and sublicense the "DHL" trademark in the United States, and DHLI had corresponding rights overseas. The agreement included reciprocal performance standards, and DHL and DHLI agreed to compensate each other, at cost plus 2%, for any shipment imbalances between the two entities. The agreement was terminable only for cause and had a 15-year term, with an automatic 10-year renewal if both parties were satisfied. If the agreement was terminated, DHLI would be prohibited from using the "DHL" trademark for 5 years. The agreement contained no provision for payment of royalties for DHLI's use of the trademark.
From late 1986 to early 1988, DHL and DHLI negotiated with United Parcel Service ("UPS") concerning merger possibilities, but these negotiations broke down over price. UPS expressed little or no interest in the "DHL" trademark during these negotiations.
On December 21, 1988, Japan Airlines Co., Ltd. ("JAL") and Nissho Iwai Corp. ("NI") made an offer to purchase up to 80% of the combined DHL network. This offer was not well received, in part because Hillblom, a leading shareholder of both DHL and DHLI, did not want to give up his entire interest in DHL. A second offer was made on June 14, 1989. JAL and NI offered to purchase 60% of DHLI/MNV based on a total value for those companies of $450 million, and to purchase the trademark for $50 million. DHL counter-offered with a $100 million price for the trademark and a $500 million price for DHLI/MNV. However, in December 1989, the parties reached a memorandum of understanding for the sale based on the $450 million value for DHLI/MNV and the $50 million price, "subject to confirmation of the tax effect," for the trademark.
During the course of the negotiations, different parties provided a number of valuations of the DHL network and the "DHL" trademark. In February 1989, Robert Fleming Co. valued DHLI/MNV in a range of $392.2 to $680.4 million, and found that the "DHL" name, while intangible, was of some value that should be reflected in the final price. Peers and Co. produced a report on June 8, 1989, valuing DHLI/MNV at $522 to $580.9 million. In a revised report of September 14, 1989, it placed the value at $625 to $700 million. In June 1989, Nicholas Miller of Coopers & Lybrand valued the "DHL" trademark, outside the United States, at $25 million. This valuation was based in part on the view that DHL's trademark rights were diluted by its agreements with DHLI. On February 23, 1990, First Boston, retained by Lufthansa (JAL and NI's new partner), valued DHLI/MNV at $400 to $600 million and the trademark at $100 to $200 million. The First Boston trademark valuation, however, appears to have been done without knowledge of any ownership problems in the trademark.
On May 31, 1989, a Coopers & Lybrand report, commissioned by the foreign investors, raised the following concerns relevant to a possible purchase of DHLI/MNV: (1) DHL should receive an injection of capital via sale of the trademark; (2) DHL might be charged with imputed income based on prior uncharged royalties; and (3) DHL, in a trademark sale, should not have to pay royalties given its difficult financial position. DHL representatives also began to express concern about the tax consequences of the sale of the trademark, and they therefore sought a lower value for the trademark. As a result of these concerns, in July 1990, DHL sought a comfort letter from Bain & Co. on a $20 million trademark valuation. Bain supported the $20 million valuation after taking into account DHLI's possible ownership of the trademark and encumbrances in the form of royalty-free licenses to both DHLI (for the non-U.S. trademark interest) and DHL (for the U.S. trademark interest). On July 9, 1990, DHL and DHLI executed an agreement granting DHLI an option to purchase the "DHL" trademark for $20 million.
In late 1989, Lufthansa joined JAL and NI (collectively, the "Consortium"). On December 7, 1990, the Consortium and DHL/DHLI reached a final agreement under which the Consortium acquired (1) a 12.5% stock interest in DHLI/MNV, with an option to purchase an additional 45% interest based on a $450 million valuation of DHLI/MNV; (2) a 2.5% interest in DHL; and (3) an option to purchase the "DHL" trademark for $20 million, conditional upon the Consortium having first exercised its option to purchase the additional 45% interest.
The trademark option provided that DHL could use the "DHL" trademark in the United States royalty-free for 15 years. After 15 years, DHL would have the exclusive U.S. rights to the trademark for 10 years, but would have to pay a royalty fee of 0.75%. The final trademark purchase and sale agreement allocated the $20 million for the trademark in the following way: $17 million for the transfer of U.S. trademark rights, and $3 million for a quitclaim in the non-U.S. trademark rights. These two interests were to be transferred to separate entities.
The two-step acquisition process was designed to give the Consortium an opportunity to learn more about the DHL network prior to making a control commitment. During the interim period,...
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