Oil Base, Inc. v. CIR

• Decision Date: 23 May 1966
• Docket Number: No. 20073.,20073.
• Parties: OIL BASE, INC., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

362 F.2d 212 (1966)

OIL BASE, INC., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 20073.

United States Court of Appeals Ninth Circuit.

May 23, 1966.

Wilson B. Copes, Los Angeles, Cal., for petitioner.

C. Moxley Featherston, Acting Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Stephen H. Paley, Attorneys, Dept. of Justice, Washington, D. C., for respondent.

Before MERRILL and BROWNING, Circuit Judges, and THOMPSON, District Judge.

MERRILL, Circuit Judge.

Petitioner as taxpayer seeks review of a Tax Court decision respecting income taxes for the taxpayer's fiscal year ending September 30, 1959. The case involves allocation of income between the taxpayer and its subsidiary, a wholly owned Venezuela corporation, Oil Base de Venezuela, C. A. (hereinafter referred to as "Obvenca"), which, during the year in question, served as taxpayer's foreign sales representative.

The income derived by Obvenca was attributable to commissions and discounts allowed by the taxpayer pursuant to an agreement between the two companies. Finding these commissions and discounts to be roughly twice as large as those paid or allowed by taxpayer in agreements with five separate uncontrolled foreign sales representatives (including Obvenca's Venezuelan predecessor and three of Obvenca's subagents), the Commissioner, under section 482, Internal Revenue Code of 1954,¹ rejected the terms of the agreement as not clearly reflecting the income of the parties and having the effect of improperly shifting income from taxpayer to its controlled foreign subsidiary. Pursuant to Treasury Regulations² the Commissioner allocated to taxpayer that income which the arm's-length arrangements with uncontrolled foreign sales representatives would have produced.³ The Tax Court supported the Commissioner. We agree.

As stated by the Tax Court in its opinion:

"The burden is on petitioner to show error in respondent\'s allocation and respondent\'s determination must be sustained unless it is unreasonable, arbitrary or capricious."

Taxpayer contends here, as it did before the Tax Court, that the Commissioner has erred in establishing by regulation and using here a standard of arm's-length bargaining. Taxpayer points out that no such standard is contained in the statute. It contends that under the statute the question is not what income arm's-length bargaining would have produced, but what income properly is attributable to each of the two commonly held corporations as its true net income in light of what each performs or produces. Relying on this court's decision in Frank v. International Canadian Corporation, 308 F.2d 520, 528-529 (9th Cir. 1962), it contends that in the present case the question is whether the income reported by taxpayer is a fair and reasonable return on its retained manufacturing activity.⁴

We cannot agree. Where, as here, the extent of the income in question is largely determined by the terms of business transactions entered into between two controlled corporations it is not unreasonable to construe "true" taxable income as that which would have resulted if the transactions had taken place upon such terms as would have applied had the dealings been at arm's length between unrelated parties.

Frank v. International Canadian Corporation, supra, did not hold that the arm's-length standard established by regulation was improper. It held that it was not "the sole criterion" for determining the true net income of each controlled taxpayer. However, permissible departure from the regulation's arm's-length standard was, under the facts of that case, very narrowly limited⁵ and the holding has no application to the facts before us.

We conclude that the arm's-length bargaining standard was properly applied pursuant to regulation. Hall v. Comm'r, 294 F.2d 82 (5th Cir. 1961).

Taxpayer contends that certain factors bearing on Obvenca's business activities distinguish its situation from that of its predecessor and render the arm's-length history irrelevant and its return inadequate. It contends that adjustment should be made to compensate for these factors and that doubling the commissions and discounts previously paid was reasonable adjustment.

The Tax Court considered these factors and rejected taxpayer's contentions with respect to them. For the reasons expressed by the court we do not regard this ruling as arbitrary or unreasonable under the circumstances.

Affirmed.

1 Internal Revenue Code of 1954 "SEC. 482. ALLOCATION OF...