Schering Corp. v. Comm'r of Internal Revenue
| Decision Date | 23 January 1978 |
| Docket Number | Docket No. 8831-75. |
| Parties | SCHERING CORPORATION and SUBSIDIARIES, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
T, a United States corporation, owned all of the stock of S, a Swiss corporation. On audit of T's Federal Corporate income tax returns for 1961-63, the Commissioner exercised his authority under section 482, I.R.C. 1954, to reallocate to T certain income which S had reported as its income, and on which S had paid Swiss income taxes. The reallocated income represented a portion of certain royalties and amounts received by S pursuant to licensing agreements. Similar reallocations were made to T in respect of income received by a Swiss sales corporation that was wholly owned by S. The Commissioner and T executed closing agreements on Sept. 23, 1969, by which T consented to the reallocations for 1961-63 and elected the benefits of Rev. Proc. 65-17, 1965-1 C.B. 833, relating to repatriation of amounts reallocated under sec. 482 from a foreign corporation to a domestic corporation. In December 1969, S declared a dividend in the amount of the sec. 482 reallocations; S paid the dividend to T, less a 5 percent Swiss withholding tax, under authority of the Federal Withholding Tax Act of Switzerland and the Income Tax Convention between the United States and Switzerland. T claimed a foreign tax credit under sec. 901 in the amount of the Swiss withholding tax. Held, the Swiss withholding tax withheld and paid to Switzerland by S is a creditable income tax of T within the meaning of sec. 901. Richard H. Appert and Emanuel G. Demos, for the petitioners.
Marwin A. Batt, for the respondent.
The Commissioner determined a deficiency in petitioner's Federal corporate income tax for the calendar year 1969 in the amount of $143,085.07. The sole issue raised by the petition is whether petitioner is entitled, pursuant to section 901(a), I.R.C. 1954, to a credit of $224,074 for amounts withheld and paid to Switzerland by petitioner's Swiss subsidiary as a withholding tax on amounts repatriated to petitioner pursuant to Rev. Proc. 65-17, 1965-1 C.B. 833, subsequent to a reallocation of income to petitioner from its Swiss subsidiary under section 482.
Most of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioner Schering Corp. is a New Jersey corporation whose principal place of business on the date it filed its petition herein was Kenilworth, N.J. Petitioner filed its Federal corporate income tax return for the calendar year 1969, on an accrual basis, with the District Director, Newark, N.J. That return was filed as a consolidated return of petitioner and its domestic subsidiaries, Schering Transamerica Corp. and Bayton Realty Corp.
Petitioner was formed in 1952 to take over certain assets held by the alien property custodian, and is now a major pharmaceutical firm. Its stock is traded on the New York Stock Exchange. It and its subsidiaries and affiliates develop, produce, and sell drugs and drug-related products and notions worldwide. Their worldwide sales have increased over the years and their organization has changed to meet operational requirements.
In 1956, petitioner organized Scherico, Ltd. (Scherico), a Swiss corporation, to own foreign patent rights, to carry out all activities necessary with respect to such patent rights, and to receive foreign royalties from licensing agreements. Scherico, from its incorporation to the present, has been wholly owned by petitioner. In 1956, 1957, and 1958, petitioner sold to Scherico for $40,212.27 in cash, foreign patents and patent applications. In 1959 and 1960, petitioner transferred other foreign patent rights to Scherico without consideration under petitioner's documentation reciting that they were contributions to capital. Additionally, petitioner in 1956 assigned to Scherico, without further consideration, various license agreements with third parties based on the aforementioned patents. During the years 1956-63, Swiss income taxes were imposed on Scherico and computed on its income without deduction for any portion of the royalty or licensing income later reallocated to petitioner under section 482.
Essex Chemie A. G. (Essex) is a Swiss corporation formed in 1959. It became a wholly owned subsidiary of Scherico on November 14, 1962, and has remained such ever since. On April 26, 1963, Essex entered into a distributorship agreement with the petitioner covering Europe, the Middle East, and the Far East. It became a “trading company” which purchased drug products, either in the form of bulk goods or substances (goods finished chemically, but requiring some further processing, packaging or labeling to be in the form suitable for sale to the public, such as being formed into a pill or being inserted in a vial) or in the form of finished goods (goods not only chemically finished but also in the form in which sold to the public) which it then resold.
The Commissioner mailed to petitioner a statutory notice of deficiency on March 11, 1966, with respect to taxable years 1955, 1956, and 1957, and a petition was filed in the Tax Court as docket No. 2986-66. The Commissioner mailed to petitioner a statutory notice of deficiency on February 16, 1967, with respect to taxable years 1958, 1959, and 1960, and a petition was filed in the Tax Court as docket No. 2296-67. One of the principal issues in these cases was the Commissioner's reallocation from Scherico to the petitioner of all of the royalty income on the patents and license agreements which petitioner had transferred to Scherico. (The Commissioner allowed petitioner a credit for foreign taxes paid by Scherico for the years 1956 and 1957, and indicated that consideration would be given to such allowance for the remaining years upon petitioner's submitting proof of the withholding and payment of such taxes.) The cases involving the years 1955-60 were settled and a collateral agreement dated September 23, 1968, was executed. The settlement consisted of an agreement that all royalties accrued on the aforementioned patents and licensing agreements as of August 1956 were to be allocated to and included in the income of petitioner. All other royalty income from the patents and licensing agreements transferred from 1956 through 1960 was to be treated as follows: for a period of 17 years from the date of the transfer of the patents and transfer of the licensing agreements to Scherico, an amount equal to 75 percent of the gross royalty income accrued by Scherico was includable in petitioner's taxable income for each year. Of this amount, 66 percent of the gross royalties was includable as gain from the sale of capital assets held for more than 6 months and the remaining 9 percent was includable as ordinary income. (Credits for the foreign taxes withheld on the royalty payments to Scherico were disallowed except that the amount of $26,460 was allowed with respect to the year 1956.)
The petitioner's tax returns for the years 1961, 1962, and 1963 were audited, and proposed deficiencies were appealed to the Appellate Division of the Internal Revenue Service. One of the issues in dispute was whether petitioner should include in income for those years any amounts with respect to the royalty income arising from the patents and licensing agreements transferred to Scherico from 1956 through 1960, which were the subject of the settlement and collateral agreement for the years 1955-60. The patent and royalty issues for 1961-63 were settled on the same basis as the settlement for 1955-60 and a closing agreement pursuant to section 7121, I.R.C. 1954, was executed on September 23, 1969.
Another issue raised for 1961-63 was the propriety of the selling prices charged by petitioner for material sold to Essex. The Commissioner asserted administratively, for 1963, that the sales prices charged by petitioner to Essex were not arm's length and that an allocation under section 482 was required. This issue was disposed of with an agreement increasing the sales price, and a closing agreement under section 7121 was executed on September 23, 1969.
The closing agreement entered into by the petitioner and the Commissioner with respect to the royalty and licensing income of Scherico made the following provisions for the allocation of such income to petitioner under section 482 and corresponding relief to petitioner under Rev. Proc. 65-17, 1965-1 C.B. 833:
NOW IT IS HEREBY DETERMINED AND AGREED for Federal income tax purposes that:
(a)(1) The said taxpayer's taxable income for the years for which section 482 allocation is made, is increased and the income of the other entity is decreased by the amount of the section 482 allocations as shown in Schedule I which is attached hereto and made a part of this agreement.
(2) The earnings and profits of the said taxpayer and the other entity are adjusted as indicated in Schedule I.
(b) The said taxpayer elects to establish and record an account receivable from Scherico, Limited, the other entity with which it engaged in the arrangement giving rise to the section 482 allocation, reflecting the following balances, such account receivable being determined to have been created as of the last day of each of the taxpayer's taxable years, for which allocation under section 482 has been made to the extent of the increase in such balance for each such year;
(c)(1) The amount of interest on the account receivable described in clause (b) above which is includible in the taxable income of the said taxpayer shall be at...
To continue reading
Request your trial
-
Inverworld, Inc. v. Commissioner, Docket No. 27089-90.
...income of the group as a whole, as well as its individual members, must be accurately determined. See Schering Corp. & Subs. v. Commissioner [Dec. 34,929], 69 T.C. 579, 600 (1978), and the case cited therein. Accordingly, each controlled taxpayer will be examined independently to determine ......
-
Sundstrand Corp. v. Comm'r of Internal Revenue
...901, it must be the “‘substantial equivalent of an “income tax” as the term is understood in the United States.”’ Schering Corp. v. Commissioner, 69 T.C. 579, 591 (1978). Whether petitioner is entitled to a credit under section 901 must ultimately be determined under U.S. tax concepts and n......
-
Analog Devices, Inc. v. Comm'r
...of the parties' Rev. Proc. 99-32 closing agreement on our analysis of section 965(b)(3). See id. at 234. Relying on Schering Corp. v. Commissioner, 69 T.C. 579 (1978), we stated that Rev. Proc. 99-32, supra, does not preclude all collateral Federal income tax consequences. We held that the ......
-
BMC Software Inc. v. Comm'r
...), and after a section 482 adjustment, did not preclude all collateral Federal income tax consequences. See Schering Corp. v. Commissioner, 69 T.C. 579, 1978 WL 3378 (1978). The taxpayer in Schering was a U.S. corporation that established accounts receivable by closing agreement to be “free......
-
Now what? Collateral consequences of transfer pricing adjustments.
...is required in litigation situations. See Rev. Proc. 65-17, [subsections] 5.02-5.04. (18) Rev. Proc. 91-24, 1991-1 C.B. 542. (19) 69 T.C. 579 (1978), acq. 1981-1 C.B. 2. (20) Paragraph 184 of the OECD Report states that loan treatment is not common. (21) Rev. Rul. 82-80, 1982-1 C.B. 89. (22......
-
Proposed revision of Revenue Procedure 65-17: adjustments required after a section 482 allocation.
...setoff against Subpart F income should be permitted. See I.R.C. [sections] 954(b)(5). See Schering Corp. v. Commissioner, 69 T.C. 579 (1978), acq., 1981-1 C.B. 2 (result only) (Swiss withholding tax on dividend in the amount of section 482 allocation is creditable income tax). (19) 1976-2 C......
-
FTC denied if competent authority not used in transfer pricing cases.
...to seek competent authority treatment in order to insure creditability of a foreign tax was challenged and rejected in Schering Corp., 69 TC 579 (1979), acq. 1981-2 CB 2, the Service continued to state its position in Regs. Sec. 1.901-2(e) (5)(i), issued in 1983. Indeed, the position was re......