DHL Corporation and Subsidiaries v. Commissioner of Internal Revenue, 123098 FEDTAX, 19570-95

Docket Nº:19570-95, 26103-95
Opinion Judge:GERBER, Judge
Party Name:DHL CORPORATION AND SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:Lawrence L. Hoenig, Frank E. Sieglitz, William E. Bonano, Sarah G. Flanagan, John M. Grenfell, Roderick M. Thompson, Debra L. Zumwalt, Richard E. Nielsen, Greg L. Johnson, Andrew D. Mastin,and Susan T. Brown, for petitioners. Mary E. Wynne, Erin M. Collins, Cynthia K. Hustad, Michael J. Cooper, K...
Case Date:December 30, 1998
Court:United States Tax Court
 
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T.C. Memo. 1998-461

DHL CORPORATION AND SUBSIDIARIES, Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Nos. 19570-95, 26103-95

United States Tax Court

December 30, 1998

          Lawrence L. Hoenig, Frank E. Sieglitz, William E. Bonano, Sarah G. Flanagan, John M. Grenfell, Roderick M. Thompson, Debra L. Zumwalt, Richard E. Nielsen, Greg L. Johnson, Andrew D. Mastin,and Susan T. Brown, for petitioners.

          Mary E. Wynne, Erin M. Collins, Cynthia K. Hustad, Michael J. Cooper, Kevin G. Croke, Kimberley J. Peterson, and James R. Robb, for respondent.

         CONTENTS

Findings of Fact ................................................................................................................................. 4

I. Background .................................................................................................................................... 4

II. Stock Ownership and Control ........................................................................................................ 13

         III. Operating Agreements Between

DHL and DHLI and Related Entities .................................................................................................... 21

IV. Development and Use of the DHL

Trademark and Logo ............................................................................................................................ 26

V. Financial Condition of DHL .............................................................................................................. 33

VI. Negotiations with UPS .................................................................................................................... 37

VII. 1990-92 Transaction With Foreign

Investors ................................................................................................................................................ 37

VIII. The Imbalance and Transfer Fees ................................................................................................... 61

IX. Technology and Systems ................................................................................................................. 66

X. Respondent's Determination ............................................................................................................... 68

Opinion .................................................................................................................................................. 71

I. Background ......................................................................................................................................... 71

II. Were Respondent's Determinations in the Notices of Deficiency Arbitrary, Capricious, or

Unreasonable? ......................................................................................................................................... 73

III. The Question of Control .................................................................................................................... 81

A. Was There Common Control

After December 7, 1990? ......................................................................................................................... 82

B. Effect of the Trademark Transfer After the Foreign Investors Attained Their Collective Shareholding Majority of the New DHLI/MNV

Entity ........................................................................................................................................................ 85

IV. Ownership and Value of the DHL

Trademark ................................................................................................................................................ 87

A. Ownership ............................................................................................................................................ 87

B. Value of the DHL Trademark ................................................................................................................ 99

1. Effect of Section 482 Regulations on Allocation of Value ......................................................................... 125

2. Respondent's Alternative Argument--The Alstores

Doctrine ......................................................................................................................................... 131

V. Allocation of DHLI Income to DHL From Imputed Royalties, Imbalance, Transfer, and Network Fees for the Period 1974 Through 1992 ........................................................................................................................ 133

A. Background ................................................................................................................................ 133

B. Royalties ..................................................................................................................................... 135

C. Imbalance and Transfer Fees ........................................................................................................ 141

D. Network Fee ................................................................................................................................ 155

VI. Are Petitioners Entitled to Setoffs to Any of the Section 482 Allocations That Have Been Sustained? .............. 159

VII. Section 6662 Penalties .............................................................................................................. 163

Appendix .......................................................................................................................................... 171

          MEMORANDUM FINDINGS OF FACT AND OPINION

          GERBER, Judge

         Respondent determined deficiencies in income tax and penalties for petitioners' 1990, 1991, and 1992 taxable years as follows:

Additions to Tax

Year

Deficiency

Sec.6662(a)

Sec. 6662(h)

1990

$194,534,167

$3,036,446.00

$71,740,776

1991

13,912,891

1,599,675.20

2,365,806

1992

216,139,109

1,835,598.00

82,784,448

         In addition, respondent denied timely filed claims for refund by petitioners with respect to the taxable years ended December 31, 1990, 1991, and 1992, in the amounts of $62,851, $920,991, and $3,208,934, plus interest thereon, respectively.

         The following issues remain for our consideration: (1) Whether respondent's determinations in the statutory notices of deficiency were arbitrary, capricious, or unreasonable; (2) whether petitioners and certain other entities were commonly controlled, for purposes of section 482,1 on or after December 7, 1990; (3) whether petitioners realized additional capital gain on the sale of the DHL trademark; (4) whether petitioners' postsale retention of a 15-year free domestic use of the DHL trademark results in capital gain income; (5) whether petitioners, under section 482, had additional income from forgone royalties; (6) whether petitioners, under section 482, had additional income attributable to imbalance and transfer fees; (7) whether petitioners, under section 482, had additional income from network fees; (8) whether petitioners correctly computed their net operating loss carryover deductions for 1990 and 1991;2 (9) whether petitioners are entitled to setoffs in any year in which additional section 482 income is finally determined; and (10) whether petitioners are liable for penalties under section 6662(a) and/or section 6662(h) for taxable years 1990, 1991, and/or 1992.

         FINDINGS OF FACT

         I. Background

         Petitioners are DHL Corp. (DHL or petitioner), formed in 1969 in California, and affiliated subsidiaries. At the time of the filing of the petitions in these cases, petitioners' principal place of business was Redwood City, California. Petitioner was formed by Adrian Dalsey (Dalsey), Larry Hillblom (Hillblom), and Robert Lynn, and the first initial of each last name was used to form the "DHL" name. Lynn transferred his interest to Hillblom and Dalsey, each of whom owned 50 percent of petitioner as of November 1972, and Dalsey retired in 1984, and his shares were redeemed or transferred to other shareholders.

         Petitioner's initial business activity was to pick up and deliver time-sensitive documents and small packages by means of regularly scheduled domestic airline flights between Hawaii and California. During 1970, a California corporation was formed to handle documents and packages between Los Angeles and San Francisco. Hillblom recruited John T. Atwood (Atwood) and William A. Robinson (Robinson) from another courier service to operate the Los Angeles to San Francisco business, which was merged with DHL on November 11, 1972, at which time Robinson and Atwood were each given a 7-percent stockholding interest in DHL. During 1972, a station was established in Hong Kong and incorporated there under the name Document Handling Limited, International (DHLI). DHLI was incorporated in Hong Kong on March 14, 1972, and its stock was owned 99 percent by DHL and 1 percent by Dalsey. Po Chung, a Hong Kong resident, was recruited by Dalsey to act as DHLI's first manager. By late 1972 or early 1973, DHL was also offering service through a variety of entities to Guam, Hong Kong, the Philippines, Japan, Thailand, Australia, and New Zealand.

         The national and international expansion of DHL's activity was accomplished by employees and/or stockholders going to a new location to establish an operational system/entity to facilitate pickup and delivery of documents and small packages to and from the United States and other locations. During 1972, Robinson traveled to Sydney, Australia, and met David Allen (Allen), and they began a pickup and delivery service there. Early on, employees who established the service in some locations accepted equity interests because of insufficient funds to pay them.

         Setting up an international station generally...

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