LUFKIN FOUNDRY AND MACHINE COMPANY v. Commissioner
| Decision Date | 12 May 1971 |
| Docket Number | 1334-68.,Docket No. 1333-68 |
| Citation | 1971 TC Memo 101,30 TCM (CCH) 400 |
| Parties | Lufkin Foundry and Machine Company v. Commissioner. Lufkin Foundry and Machine Company International v. Commissioner. |
| Court | U.S. Tax Court |
Thomas M. Haderlein, John C. Klotsche and Marcellus R. Meek, Suite 700, Prudential Plaza, Chicago, Ill., for the petitioners. Harold Friedman, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined the following Federal income tax deficiencies against the petitioners in these consolidated cases:
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Petitioner Docket No. Year Amount
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Lufkin Foundry and Machine Company ............. 1333-68 1961 $ 82,360.72
1962 130,004.67
Lufkin Foundry and Machine Company International 1334-68 1961 10,156.38
1962 29,261.33
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The issues for decision are: (1) Whether respondent erred in determining that a portion of the commissions paid by Lufkin Foundry and Machine Company to Lufkin Foundry and Machine Company International and Lufkin Overseas Corporation, S. A., during 1961 and 1962 constituted an improper shifting of income to those corporations by Lufkin Foundry and Machine Company under section 482;1 (2) whether respondent erred in determining that a portion of the discounts granted by Lufkin Foundry and Machine Company to Lufkin Foundry and Machine Company International during 1961 and 1962 constituted an improper shifting of income under section 482; and (3) whether petitioner, Lufkin Foundry and Machine Company International, qualified as a Western Hemisphere trade corporation within the meaning of section 921 during 1961 and 1962.
Some of the facts have been stipulated by the parties and are found accordingly.
Lufkin Foundry and Machine Company (herein called Lufkin) is a corporation organized under the laws of the State of Texas whose principal office was located at 407 Kiln Avenue, Lufkin, Texas, at the time it filed its petition herein. Lufkin was incorporated on March 4, 1902. Lufkin maintained its books and filed its Federal income tax returns for the taxable years ended December 31, 1961, and December 31, 1962, on an accrual basis of accounting. Its corporate income tax returns for each of the years 1961 and 1962 were filed with the district director of internal revenue, Dallas, Texas.
Lufkin Foundry and Machine Company International (herein called Lufkin International) is a corporation organized under the laws of the State of Texas whose principal office was located at 407 Kiln Avenue, Lufkin, Texas, at the time it filed its petition herein. Lufkin International maintained its books and filed its Federal income tax returns for the taxable years ended December 31, 1961, and December 31, 1962, on an accrual basis of accounting. Its corporate income tax returns for 1961 and 1962 were filed with the district director of internal revenue, Dallas, Texas.
Lufkin is engaged principally in the business of manufacturing and selling oil field pumping units, truck trailers, marine and industrial gears, oil field equipment and other related types of machinery and equipment and spare and replacement parts therefor. Lufkin's operations are divided into three divisions: the trailer division, the mill supply division and the machinery division. Oil field pumping units are the principal product manufactured by the machinery division and the principal product sold by Lufkin in export.
Lufkin manufactures four basic types of oil field pumping units: an air balanced unit, a beam balanced unit, a crank balanced unit and a Mark II Unitorque unit. The Mark II Unitorque unit is a variation of the crank balanced unit. The basic difference between the four types of pumping units relates to what is known as the counterbalancing system. The object of counterbalance in a pumping unit system is to make maximum utilization of the overall available energy. Different types of units can better utilize input energy depending on the various conditions of the oil well such as the depth and the desired fluid production.
There are numerous sizes and combinations of Lufkin oil field pumping units within the four basic types. The conventional crank balanced unit alone has at least one hundred variations.
During 1961 and 1962 the price range on Lufkin oil field pumping units ranged from $600 to $800 for the smallest unit to $35,000 to $38,000 for the largest, exclusive of the prime mover and freight and installation charges.
During 1961 and 1962, Lufkin was in competition for the sale of its pumping units, both domestically and in export with companies such as Oil Well Supply Co. (U. S. Steel), Continental Emsco Co. (Youngstown Steel) and National Supply Co. (Armco Steel) domestically and Wuffel, Legrande and SIAM in foreign areas. Lufkin, however, ranked first in worldwide sales during this period.
From 1927 to 1949, Lufkin conducted its export operations exclusively through an export agent, A. V. Simonson. Mr. Simonson was an independent agent operating out of New York City, with no employees or agents outside the United States selling Lufkin equipment. In addition to Lufkin pumping units, Mr. Simonson acted as an agent on behalf of other companies including Gaso Pump and Burner Manufacturing Company, Franks Manufacturing, Buda Engines, and Centure Geophysical Company. Mr. Simonson's activities generally involved visiting customers in the New York area. He did not prepare specifications or make quotations for Lufkin equipment.
During this period, Lufkin's major export customers of oil field pumping units were Standard Oil of New Jersey, Shell Oil Company and Texaco. Field personnel of the customer played a very limited role in purchasing Lufkin pumping units. Generally, people in the field would provide the New York purchasing office of the customer with minimal well conditions which would be passed on to Mr. Simonson in New York for transmission to Lufkin, Texas. A recommendation for a specific unit would be made to the New York purchasing office of the customer which would be sent to the field. Often the field personnel would then request further recommendations. Basically, field personnel of the customer did not specify Lufkin units and were not involved in the actual purchasing of Lufkin pumping units. The lack of specifications from the field created a multitude of problems in furnishing the customer with appropriate equipment.
Lufkin organized and, at all times pertinent hereto, owned all of the outstanding capital stock of the following corporations:
Place of Year of
Name Incorporation Incorporation
Lufkin Machine Co
Ltd. ............................ Canada 1949
Lufkin Foundry and
Machine Company
International ................... Texas 1954
Lufkin Overseas Corporation
S. A. ........................... Venezuela 1958
The first subsidiary corporation formed by Lufkin to engage in international business was Lufkin Machine Co. Ltd. (herein called Lufkin Canada), a Canadian corporation organized on November 19, 1949.
The organization of Lufkin Canada was precipitated by Imperial Oil Company, a subsidiary of Standard Oil of New Jersey. Imperial Oil Company indicated to Lufkin that if Lufkin wished to do business with Imperial Oil Company in the new oil fields in Western Canada, Lufkin would have to provide a warehouse for parts, servicemen familiar with the equipment, personnel capable of specifying proper equipment, and all other facilities necessary to maintain oil field pumping units. Lufkin initially hired an independent agent in Canada to perform these functions but this arrangement did not work out satisfactorily and Lufkin Canada was thereupon organized.
Although Lufkin was hesitant to organize a new company in Canada, Lufkin Canada was formed as a separate subsidiary corporation rather than as a branch of Lufkin. Lufkin was advised by its attorneys that such a separate vehicle would be desirable to insulate the assets of Lufkin from potential liability arising out of Canadian activities. Lufkin was also advised that from an accounting standpoint a separate corporate vehicle would be desirable in Canada.
Immediately after the formation of Lufkin Canada, Charles Dyer was sent to Edmonton, Alberta, Canada, as manager of Lufkin Canada. Mr. Dyer had been a sales engineer for Lufkin working in the Eldorado, Arkansas, area. Mr. Dyer hired an associate, purchased land and a warehouse facility and ordered a stock of pumping units and parts from Lufkin. Lufkin Canada initially serviced the areas of Devon La Duc and Red Water which are 30 and 50 miles, respectively, from Edmonton. Later, Pemberton, which is approximately 100 miles from Edmonton, was also serviced by Lufkin Canada.
From February 21, 1950, to May 1, 1954, Lufkin Canada purchased Lufkin pumping units and spare and replacement parts from Lufkin for resale in Western Canada. All purchases of Lufkin equipment by Lufkin Canada were made pursuant to a sales and service agreement between the parties dated February 21, 1950 (herein referred to as Lufkin Canada Agreement). Pursuant to the Lufkin Canada Agreement, Lufkin appointed Lufkin Canada as its exclusive distributor of Lufkin equipment in Western Canada and granted to Lufkin Canada the right to purchase Lufkin pumping units and parts at list price less 10 percent, F. O. B. Lufkin, Texas.
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