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IRS loses Sundstrand - again.

Showing once again its never say die" attitude when it comes to pursuing transfer pricing cases, the IRS attempted to make a section 482 adjustment to Sundstrand Corporation for the years 1979 and 1980-even though it had lost the issue for the years 1977 and 1978 in Sundstrand v. Commissioner [96 T.C. 266 (1991)]. This time around, Tax Court Judge Hamblen ruled the IRS was prevented from relitigating the issues decided in the earlier case (Sundstrand v. Commissiner, T.C.M. 1992-86).

At that time, Sundstrand had established a Singapore subsidiary, SunPac, to manufacture and distribute a certain air-plane part. SunPac paid Sundstrand a royalty of 2%. Sundstrand purchased all SunPac's output through 1978 at its catalog price less a 15% discount.

In a scathing opinion for both sides, Judge Hamblen held SunPac was not a subcontractor and the IRS's adjustment was unreasonable, even though the royalty and transfer price were not "arm's length." He determined a proper royalty was 10% and the arm's-length transfer price should be the catalog price less a 20% discount.

The IRS then made adjustments for taxable years 1979 and 1980 to both the transfer price and the royalty rate. Sundstrand filed a motion for partial summary judgment, arguing the IRS was collaterally estopped from relitigating the section 482 issues decided earlier (collateral estoppel is the legal doctrine that, in a new proceeding, sustains the conclusiveness of a judgment rendered in an earlier action).

Judge Hamblen granted the motion in part. He rejected the IRS's argument that collateral estoppel was inappropriate because of newly discovered evidence, saying the IRS could have employed administrative summonses or other procedures to obtain the new evidence earlier. He held the IRS was barred from asserting a royalty rate for 1979 and 1980 different from the royalty he imposed for 1977 and 1978 in the first Sundstrand case.

Although Judge Hamblen applied the law of collateral estoppel to prevent relitigation, he accepted, in part, the IRS's challenge to the transfer price. He ruled the distributor agreement was a "dynamic instrument which was to be changed as the parties' pricing experience dictated." Nonetheless, he held the IRS was prevented from challenging the catalog price as the base price.

Observation: The IRS has been relentless in its pursuit of perceived transfer pricing abuses, despite the fact it usually loses large portions of its adjustments. There are at least 26 cases docketed in Tax Court, with aggregate adjustments in the billions. The IRS also has j st issued a set of proposed section 482 regulations. This is the issue to watch in the 1990s. Edited by Robert Willens, CPA, senior vice-president at Lehman Brothers, New York City corporate); Marianne Burge, CPA, director of international tax services, Kenneth Kral, CPA, international tax partner, and Marylouise Dionne, Esq., international tax manager, at Price Waterhouse, New York City international).
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Title Annotation:Sundstrand v. Commissioner
Publication:Journal of Accountancy
Date:May 1, 1992
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