Durovic v. Comm'r of Internal Revenue

• Decision Date: 03 December 1975
• Docket Number: Docket No. 1633-65.
• Citation: 65 T.C. 480
• Parties: MARKO DUROVIC, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

65 T.C. 480

MARKO DUROVIC, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 1633-65.

United States Tax Court

Filed December 3, 1975.

Anna R. Lavin, for the petitioner.

Rex A. Guest, for the respondent.

This case, originally decided in 54 T.C. 1364 (1970), is before the Court on remand in part from the U.S. Court of Appeals for the Seventh Circuit (487 F.2d 36): (1) For further exploration of the law and the fact relating to, and a proper determination of, the rate of exchange to be used in converting Argentine expenditures in pesos, incurred prior to petitioner's emigration to this country, into dollars, and (2) to permit this Court to determine whether petitioner is entitled to a deduction for the cost of 63,903 ampules distributed without charge. Held: 1. On these facts, the so-called ‘free’ rate is the proper rate of conversion. 2. The free distribution of 63,903 ampules is a capital expenditure in the nature of goodwill. Petitioner has failed to establish a useful life over which these expenditures can be amortized and is not entitled to a deduction with respect thereto.

SUPPLEMENTAL OPINION

IRWIN, Judge:

In an opinion filed June 24, 1970 (54 T.C. 1364 (1970)), this Court made certain findings with respect to three items which entered into the computation of the costs of goods sold with respect to the production of 200,000 ampules of the drug Krebiozen by Duga Illinois, a partnership in which petitioner held a 50-percent interest.

First, we determined that the raw material cost incurred in Argentina on January 26, 1950, of the 2 grams, 35 centigrams of powder which was used to produce the 200,000 ampules of Krebiozen in the United States was M$N 3,005,000 /1/ (Argentine pesos). We further determined that the U.S. dollar equivalent of that amount should be calculated at the rate of 9.66 pesos to 1 U.S. dollar. This was based on a stipulation of the parties of a table which professed to set forth the ‘official’ and ‘commercial’ rates of exchange. We adopted the ‘commercial’ rate of exchange.

Second, the partnership incurred expenses of $105,387.28 relating to research and the sterilization, ampuling, and packaging of the drug, which was recorded in an expense journal stipulated to by the parties. Employing the Cohan rule (Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930)), we allocated onehalf of this amount to the cost of goods sold. We held the other half to be nondeductible capital expenditures (research and experimental costs).

Third, we found that although 63,903 of the 200,000 ampules of Krebiozen were distributed without charge to the medical profession in years prior to the years before the Court, the cost of goods sold should be spread over the total 200,000 ampules produced. The effect of this was to deny any allowance as a part of the cost of goods sold for the 63,903 ampules distributed without charge.

Petitioner appealed from our decision to the Court of Appeals for the Seventh Circuit claiming, inter alia, that we erred in disallowing one-half of the $105,387.38 amount and in spreading the costs over 200,000 ampules rather than over 136.097 ampules. He further claimed we erred in applying the ‘commercial’ rate of exchange of 9.66 pesos to the dollar rather than the rate of 3.36 which he urged. With respect to this latter contention, petitioner submitted that the ‘basic buying rate’ as set forth in the Federal Reserve Bulletin should be employed. As evidence of this rate was not presented to this Court, petitioner requested the Court of Appeals to take judicial notice of this Government publication.

The Court of Appeals (Durovic v. Commissioner, 487 F.2d 36 (7th Cir. 1973)) held that we erred in not allowing the full $105,387.38 to be employed in determining the cost of goods sold. That court agreed with us that the cost of producing the ampules should be spread over the 200,000 ampules actually produced. However, it remanded the case ‘to permit the Tax Court to determine whether the taxpayer is to get a deduction for the cost of the 63,903 free ampules distributed as an advertising expense or as an amortizable good will expense’ and to make a ‘recomputation in view of our findings as to the number of ampules.’

The case was further remanded for a reconsideration of the rate of conversion issue. With respect to this issue the Court of Appeals stated:

On this admittedly very unsatisfactory and unclear state of the law; (a) because of the efforts of petitioner to have us consider evidence not introduced below (by taking judicial notice of it); (b) because of the flat statements of the petitioner that Title 31, Sec. 372(b) and (c) controls not only conversion of foreign currencies with respect to Custom's collection of duties, but also with respect to all tax matters, and the failure of either side to present controlling law or convincing analogy; (c) because Barr v. United States, 324 U.S. 83, 65 S.Ct. 522, 89 L.Ed. 765, although referring specifically to ‘the search which has been made for a measure of the true dollar value of imported merchandise for customs purpose’; and the right of Congress ‘to choose any standard of evaluation for the assessment and collection of duties', allegedly prevents any judicial review of the determination and certification by the Federal Reserve Bank of New York, of the ‘buying rate’ to be used in all foreign currency conversion to which the Commissioner states this case ‘has no bearing’ on our problem: (d) because petitioner seeks to be released by this court from his stipulation with respect to Joint Exhibit 23-P (table professing to set forth official and commercial exchange rates); (e) because Exhibit C (page 1703 of the December 1950 issue of the Federal Reserve Bulletin) in the Appendix, attached to Appellant's Brief, if properly introduced into evidence, indicates there was no such thing as an authorized ‘commercial rate’ or ‘free rate’, or ‘preferential rate’, or anything other than a ‘basic’ foreign exchange rate for Argentine pesos prior to the end of June, 1950; (f) because the Commissioner in support of the Tax Court relies almost exclusively on ‘blocked currency’ cases; (g) because the Commissioner relies on ‘inevitable conclusions' that do not seem to be required by the cases submitted, which largely rest on a different factual basis; and (h) because we believe the matter must be remanded to the Tax Court for recomputation in view of our findings as to number of ampules * * * we reverse the Tax Court on the issue of conversion values and remand for further exploration of the law and the fact, and a proper determination of that issue. (487 F.2dat 48.)

The Court of Appeals notes that Argentine pesos were not blocked in early 1950 and, as will be noted from the above quote, indicates that blocked currency cases may not be necessarily relied upon in the case at bar.

Pursuant to the circuit court's mandate, we conducted a further trial to receive additional evidence. Both parties submitted additional evidence concerning the proper conversion rate. No additional evidence was presented with respect to the treatment of the 63,903 ampules which were distributed free of charge.

Except to the extent necessary to an understanding of this opinion, we shall not restate the extensive findings of fact set forth in our original opinion. See 54 T.C. 1366-1383 (1970). On appeal petitioner adopted those findings ‘as a faithful statement of the evidence.’ Pertinent facts are also summarized in the Court of Appeals decision. Durovic v. Commissioner, supra.

Rate of Exchange

We found in our original decision that petitioner, while a resident of Argentina, acquired the drug Krebiozen in raw material (powder) form from one Juan Tanoira, also a resident of Argentina, on January 26, 1950, for M$N 3,005,000 (Argentine pesos). On February 7, 1950, petitioner brought this property into the United States as a biological product without the payment of duty and contributed it as his investment in an equal partnership (Duga Illinois) with his brother, Dr. Stevan Durovic. The powder was later used in making 200,000 ampules of Krebiozen.

Petitioner's basis, and consequently the partnership's basis, in the powder used in making the drug, in terms of Argentine pesos, was M&N 3,005,000. As earlier noted, we adopted the ‘commercial’ rate of 9.66 pesos to the dollar as the proper rate of conversion. We are directed to reconsider our measurement of that basis in terms of U.S. dollars.

It is fundamental to our tax system that the determination of the amount of the cost of goods sold herein must be measured in U.S. dollars. Cf. Estate of Jan Willem Nienhuys, 17 T.C. 1149, 1163 (1952). See also Edmond Weil, Inc. v. Commissioner, 150 F.2d 950 (2d Cir. 1945); Willard Helburn, Inc., 20 T.C. 740 (1953); James A. Wheatley, 8 B.T.A. 1246, 1249 (1927). In converting the M$N 3,005,000 into U.S. dollars, the critical date is January 26, 1950, the date of petitioner's purchase of the drug it its raw material form.

The issue is complicated by the apparent existence of a number of different exchange rates during this time period and the various descriptive terms applied to them.

Petitioner, now relying upon page 1703 of the December 1950 issue of the Federal Reserve Bulletin, /2/ submits that the only rate in existence and, therefore, the applicable conversion rate should be 29.778 cents per Argentine peso, (3,3582 pesos per dollar), the ‘buying’ rate in New York for cable transfers at noon on January 26, 1950. Petitioner refers to this as ‘the basic buying rate.’ It is noted that use of this rate would result in a rounded figure of 3.36 pesos to the dollar which petitioner urged at the original trial. Petitioner argues that this is the only rate of conversion for such Argentine goods imported into the United States as of January 26, 1950, and that his position is confirmed by the circular issued by the Central Bank of Argentina dated October 3, 1949. He insists...