Nestle Holdings, Inc. v. Commissioner

• Citation: 70 T.C.M. 682
• Decision Date: 14 September 1995
• Docket Number: Docket No. 21562-90.
• Parties: Nestle Holdings, Inc., on behalf of itself and Consolidated Subsidiaries, and as the Successor in interest to Nestle Enterprises, Inc. and Consolidated Subsidiaries v. Commissioner.
• Court: United States Tax Court

70 T.C.M. 682

T.C. Memo. 1995-441

Nestle Holdings, Inc., on behalf of itself and Consolidated Subsidiaries, and as the Successor in interest to Nestle Enterprises, Inc. and Consolidated Subsidiaries v. Commissioner.

Docket No. 21562-90.

United States Tax Court.

Filed September 14, 1995.

Joel V. Williamson, Joseph R. Goeke, Daniel A. Dumezich, Roger J. Jones, David A. Hyman, David F. Abbott, Glenn A. Graff, Stephen A. Kubiatowski, Scott M. Stewart, and Jeffrey B. Frishman, Chicago, Ill., Alexander Spitzer, Gary P. Kirschenbaum, Thomas L. Kittle-Kamp, and M. Ellen Robb, for the petitioner. Theodore J. Kletnick, Jeannette D. Pappas, Rose E. Gole, Curt M. Rubin, Peter J. LaBelle, Suzanne L. Corbin, Paul L. Darcy, Elizabeth A. Maresca, Melanie M. Garger, Rajiy Madan, and Nicholas G. Kokis, for the respondent.

                                                    Table of Contents
                                                                                                            CCH Page
                   Findings of Fact .....................................................................     [685]
                  I. Corporate Structure and Business ...................................................     [685]
                 II. Carnation Acquisition ..............................................................     [685]
                     A. Background ......................................................................     [685]
                     B. Evaluation ......................................................................     [686]
                     C. Negotiation and Board Approval ..................................................     [687]
                     D. Merger Agreement ................................................................     [688]
                     E. Tender Offer and Subsequent Events ..............................................     [688]
                     F. Carnation Stock Trading .........................................................     [688]
                III. Financing of Petitioner's Acquisition of Carnation .................................     [689]
                     A. Background ......................................................................     [689]
                     B. Nestle Analysis of Acquisition Financing ........................................     [689]
                     C. Acquisition Financing ...........................................................     [690]
                

                         1. Commercial Borrowings: 4(2) Note Program ....................................     [690]
                         2. Related-Party Financing .....................................................     [690]
                     D. Petitioner's Offerings on the European Financial Market .........................     [691]
                     E. Subsequent Related-Party Advances ...............................................     [691]
                     F. Repayments on the Related-Party Financing .......................................     [691]
                         1. NSA Advance .................................................................     [691]
                         2. NSA Subsequent Advances .....................................................     [692]
                         3. Maggi Advance ...............................................................     [692]
                     G. NCC-Carnation Loans .............................................................     [693]
                     H. Petitioner's Financial Statements ...............................................     [693]
                     I. Summary of Disallowed Interest Expense ..........................................     [693]
                 IV. Section 338 Election: Valuation of Carnation Assets ................................     [694]
                     A. Background ......................................................................     [694]
                     B. Carnation Inventory .............................................................     [694]
                     C. Trademarks and Trade Names ......................................................     [695]
                     D. Unpatented Technology ...........................................................     [696]
                         1. Flash-18 ....................................................................     [696]
                         2. Drying/Instantizing .........................................................     [697]
                         3. Coating .....................................................................     [698]
                         4. Mibolerone Dog Food .........................................................     [698]
                         5. Low-pH/Hot-Fill-and-Hold ....................................................     [699]
                  V. Sales of Trademarks and Technology .................................................     [699]
                     Opinion ............................................................................     [699]
                  I. Introduction .......................................................................     [699]
                 II. Interest Deduction .................................................................     [700]
                     A. Intention to Create Debt ........................................................     [700]
                     B. Reasonable Expectation of Repayment .............................................     [701]
                     C. Economic Reality ................................................................     [701]
                III. Valuation Under Section 338 Election ...............................................     [705]
                     A. Inventory .......................................................................     [705]
                         1. Disposal Costs ..............................................................     [708]
                              a. SG&A Expenses ..........................................................     [708]
                              b. Intangible's Charge ....................................................     [710]
                         2. Holding Costs ...............................................................     [711]
                         3. Profit ......................................................................     [711]
                         4. Test of Reasonableness ......................................................     [712]
                     B. Trademarks and Trade Names ......................................................     [714]
                         1. Petitioner's Expert Report ..................................................     [714]
                              a. Profit-Split Method ....................................................     [714]
                              b. Selling-Price-Differential Method ......................................     [714]
                              c. Econometric Method .....................................................     [715]
                              d. Relief-from-Royalty Method .............................................     [715]
                         2. Respondent's Experts: Relief-from-Royalty Method ............................     [715]
                     C. Unpatented Technology ...........................................................     [717]
                         1. Graham's Analysis ...........................................................     [717]
                         2. Reilly's Analysis ...........................................................     [719]
                     D. Goodwill and Going Concern Value ................................................     [720]
                         1. Arm's-Length Bargain and Adequate Information ...............................     [721]
                         2. Control Premium .............................................................     [723]
                         3. Insider-Trading Premium .....................................................     [724]
                 IV. The Carnation Sale of Technology and Trademarks ....................................     [726]
                  V. Section 6661 Addition to Tax .......................................................     [727]
                 VI. Summary ............................................................................     [728]
                

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge:

Respondent determined deficiencies in petitioner's Federal income taxes as follows:

                Taxable Year Ended                  Amount
                December 31, 1983 ............   $ 38,934,552
                December 29, 1984 ............     21,764,946
                December 28, 1985 ............    285,591,539
                

Respondent also determined an addition to tax of $61,514,950 under section 6661 for the taxable year ended December 28, 1985. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

After settlement of numerous significant issues, the issues remaining for decision pertain to the acquisition of Carnation Co. (Carnation) by petitioner Nestle Holdings, Inc. (petitioner), and are:

(1) Whether petitioner and Carnation are entitled to interest deductions of $131,739,791;

(2) what was the fair market value (FMV) of Carnation's inventory, trademarks and trade names, unpatented technology, and goodwill and going concern as of January 10, 1985;

(3) whether Carnation must recognize capital gain on its sale of certain assets to Nestle S.A. (NSA); and

(4) whether petitioner is liable for an addition to tax under section 6661.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference.

Petitioner filed consolidated Federal income tax returns on an accrual basis during the years in issue and filed an amended Federal income tax return for the taxable year ended December 28, 1985.

I. Corporate Structure and Business

Petitioner is a U.S. domestic corporation, with its principal place of business in Stamford, Connecticut. At all material times, petitioner was a first-tier subsidiary of NSA, a publicly held corporation headquartered in Vevey, Switzerland. Through at least 25 subsidiaries, NSA was engaged in worldwide business activities, and the term "Nestle" in this opinion refers to the global family of NSA affiliated entities.

In many instances, NSA did not directly own its subsidiaries. For example, petitioner was the holding company for various Nestle operating subsidiaries located in the United States, including The Nestle Co. (later Nestle Foods Corp.); Libby McNeill & Libby, Inc.; the Stouffer Corp.; and, after 1985, Carnation. Petitioner had...