Int'l Flavors & Fragrances Inc. v. Comm'r of Internal Revenue
| Decision Date | 16 May 1974 |
| Docket Number | Docket No. 7768-70. |
| Citation | 62 T.C. 232 |
| Parties | INTERNATIONAL FLAVORS & FRAGRANCES INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
George Rowe, Jr., and Michael J. Gaynor, for the petitioner.
Marion L. Westen and Warren W. Dill, for the respondent.
Petitioner and its foreign affiliates are engaged worldwide in the manufacture and distribution of flavoring extracts. In order to offset any loss which might be sustained in event of the devaluation of the British pound sterling, petitioner entered into a short sale contract for pounds sterling. After the pound was devalued, but before the delivery date, petitioner either sold or closed out its contract. Held, the gain to petitioner on the transaction is taxable as ordinary income under the principles of Corn Products Co. v. Commissioner, 350 U.S. 46 (1955).
Respondent has asserted a deficiency in the Federal corporate income tax of petitioner for the taxable year 1967 in the amount of $73,715.
Certain concessions having been made by the parties, the following issues remain for decision:
(1) Whether petitioner's gain on a contract for the short sale of 1.1 million pounds sterling, entered into with First National City Bank and subsequently sold or transferred to Amsterdam Overseas Corp. just prior to the closing date, is taxable as ordinary income under the doctrine of Corn Products Co. v. Commissioner, 350 U.S. 46 (1955), making the gain realized on the transfer thereof taxable as ordinary income.
(2) Alternatively, whether the gain to petitioner on the above transaction should be taxable under the provisions of section 12331 on the basis that Amsterdam was, in substance, acting as a broker for petitioner in purchasing the pounds sterling used to close out the short sale.
Some of the facts have been stipulated by the parties. Such facts and the exhibits attached thereto are incorporated herein by this reference.
International Flavors & Fragrances Inc., (hereinafter referred to as petitioner of IFF (U.S.) is a New York corporation with its principal place of business in New York, N.y. Petitioner filed a United States corporate income tax return (Form 1120) and an information return with respect to controlled foreign corporations (Form 2952), respectively, for the taxable year 1967 with the district director of internal revenue, Manhatten District, New York, N.y.
IFF (U.S.) is engaged in the creation and manufacture of flavor and fragrance products used by other manufacturers to impart or improve flavor or fragrance in a variety of consumer products. Its activities are conducted on a worldwide basis through numerous foreign corporations which it, directly or indirectly, owns or controls.
IFF (U.S.) prepares consolidated financial statements which it publishes regularly to its shareholders and to the public. For the purpose of such consolidated statements, the accounts of its foreign affiliates, which are expressed in foreign currencies, are converted into United States dollars. The accounts of its foreign affiliates, however, are not consolidated for United States income tax purposes. No other financial statements are published.
Of primary concern to the present inquiry is the relationship between IFF (U.S.) and its foreign affiliate, International Flavors & Fragrances I.F.F. (Great Britain) Ltd. (hereinafter referred to as IFF (G.B.)). IFF (G.B.) is a wholly owned foreign subsidiary of International Flavors & Fragrances I.F.F. (Nederland) N.V. (hereinafter referred to as IFF (Holland)) which, in turn, is wholly owned by IFF (u.s.). IFF (G.B.) has manufacturing, research, and administrative facilities in Enfield, England. It has additional manufacturing facilities in Haverhill, England.
During the latter part of 1966, IFF (U.S.) became concerned about a possible devaluation of the British pound sterling and the adverse effect it would have in converting the operations of IFF (G.B.) into dollars for purposes of its annual consolidated statement. In a letter to the comptroller in charge of European operations for the company, H. G. Reid, Financial Vice President of IFF (U.S.), suggested that the company sell short a sufficient amount of British pounds sterling to cover, on an after-tax basis, the exposed net current assets of IFF (G.B.), approximated to be, in terms of dollars, $1,600,000. Reid accordingly recommended the purchase of a 1-year pounds sterling contract in the dollar equivalent of $3 million, since on an after-tax basis, the protection afforded from such contract would be only 53 percent thereof.
On December 29, 1966, IFF (U.S.) entered into a written contract with First National City Bank of New York (hereinafter referred to as FNCB) pursuant to which IFF (U.S.) sold to FNCB 1.1 million British pounds sterling at $2.7691 per pound, delivery and payment to be made on January 3, 1968. The price FNCB agreed to pay per pound was approximately three-fourths of 1 percent below the then-prevailing dollar-pound exchange rate of $2.7918. The discount represented consideration for the risk to FNCB in writing a 1-year contract.
The contract provided that if, prior to the closing date, the market value of pounds sterling exceeded the exchange rate which FNCB was required to pay thereunder, FNCB could request IFF (U.S.) to deposit, as security for its own obligation under the contract, cash or its equivalent. IFF (U.S.) was additionally subject to certain penalties for noncompliance with the terms of the agreement. The contract further provided that FNCB had the power to place liens on any funds of IFF (U.S.) that were or might come into the possession or control of FNCB to enforce its rights under the contract.
IFF (U.S.) had the following dollar deposits on account with FNCB as of the following dates:
+---------------------------+
¦Dec. 31, 1966 ¦$302,616.60 ¦
+--------------+------------¦
¦Dec. 20, 1967 ¦688,691.19 ¦
+--------------+------------¦
¦Jan. 3, 1968 ¦1,928,354.37¦
+---------------------------+
On November 18, 1967, the British Government devalued the pounds sterling in terms of U.S. dollar from.$2.80 to $2.40.
On December 20, 1967, IFF (U.S.) entered into an agreement with Amsterdam Overseas Corp. (hereinafter referred to as Amsterdam), a large international banking institution located at 70 Pine Street, New York City. Neither IFF (U.S.) nor Amsterdam held stock in the other. The agreement, which was in letter form from IFF (U.S.) to Amsterdam and accepted by Amsterdam, read in pertinent part, as follows:
Enclosed is the original of our agreement of December 29, 1966 with First National City Bank which we hereby sell to you today for $387,000. This sale is on the understanding that you will fulfill the obligation to deliver Sterling 1.1 million to First National City Bank on January 3, 1968 without recourse to us.
On the same day as the above agreement was entered into, the following events also transpired:
(1) IFF (U.S.) notified FNCB that it had sold its contract with FNCB to Amsterdam
(2) Amsterdam notified FNCB that it had bought the contract. It agreed to assume liability thereunder if FNCB would confirm its intent to pay the sum of $3,046,010 upon the delivery of 1.1 million pounds sterling on January 3, 1968.
(3) At 4:18 p.m., Amsterdam received notification from FNCB of its approval of Amsterdam's purchase of the contract. FNCB also confirmed that on January 3, 1968, it would credit the dollar account of Amsterdam with the difference between its own obligation under the contract, $3,046,010, and the dollar cost to Amsterdam of purchasing from FNCB, at the prevailing rate of exchange, the 1.1 million pounds sterling needed to close out the contract on such date.
(4) At 4:30 p.m., Amsterdam purchased 1.1 million pounds sterling on the rate of $2.4080 from FNCB for delivery on January 3, 1968.
On December 21, 1967, Amsterdam sent a check to IFF (U.S.) in the amount of $387,000 representing the price agreed upon for the purchase of the contract. On January 3, 1968, Amsterdam closed out the contract with the 1.1 million pounds sterling purchased short from FNCB on December 20, 1967. The net gain to Amsterdam on the transaction was $10,210.
In 1967, IFF (G.B.) paid the dollar equivalent of $476,000 in dividends to IFF (Holland). In the same year, IFF (U.S.) received the dollar equivalent of $1,421,136 in dividends from IFF (Holland).
With respect to IFF (G.B.), its assets and liabilities per books, stated in British pounds sterling, for the years 1966-68 were as follows:
+-----------------------------------------------------------------------------+
¦IFF (G.B.) COMPARATIVE BALANCE SHEET 1966-68 ¦
+-----------------------------------------------------------------------------¦
¦ ¦1966 ¦1967 ¦1968 ¦
+-----------------------------------------------+---------+---------+---------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------------------+---------+---------+---------¦
¦Current assets: ¦ ¦ ¦ ¦
+-----------------------------------------------+---------+---------+---------¦
¦Cash on hand ¦$2,191 ¦$7,439 ¦$2,389 ¦
+-----------------------------------------------+---------+---------+---------¦
¦Marketable securities ¦ ¦135,000 ¦40,000 ¦
+-----------------------------------------------+---------+---------+---------¦
¦Notes receivable—trade ¦9,155 ¦12,182 ¦7,718 ¦
+-----------------------------------------------+---------+---------+---------¦
¦Accounts receivable—trade and affiliate and ¦433,433 ¦571,521 ¦1,022,208¦
¦other ¦ ¦ ¦ ¦...To continue reading
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