In a case that had been docketed in the United States Tax Court, Caterpillar Inc. v. Commissioner, Docket No. 10790-13 (2013), the petitioner-corporation and respondent, Internal Revenue Service, entered into and filed a stipulated settlement on July 31, 2014 with the Court. In many instances a stipulated settlement will be reached by the parties prior to trial, which would further mean that no evidenced was adduced and possibly occured prior to the submission of stipulations of fact being filed with the court.
The compromise and settlement of tax cases is government by principles of contract law. Robbins Tire & Rubber Co., v. Commissioner, 52 T.C. 420, 435-436, supplemented by 53 T.C. 274 (1969); Brink v. Commissioner, 39 T.C. 602, 606 (1962), aff'd 328 F.2d 622 (6th Cir. 1964). Where a decision is entered under a stipulated settlement, the parties are generally held to their agreement without regard to whether the decision is correct on the merits. See Stamm International Corp. v. Commissioner, 90 T.C. 315, 321-322 (1988); Spencer M. Stillman, et ux., TC Memo 1995-591.
This case involved a Section 482 transfer pricing matter concerning the deductiblity (or non-inclusion of imputed income) with respect to royalty paments owed to the petitioner from its European subsidiaries in Belgium and France. The stipulated settlement requires that Caterpillar pay additional taxes totaling approximately $1.9 million for the tax years 1990 and 1992 to 1994. The amount includes a $3.3 million deficiency in tax for 1990 which is partialliy offset by a residual FTC balance of $1.475 million for the same year. The deficiency in income tax sought by the Service in its notice of deficiency was approximately $7.2 million.
The center of the controversy was the effect to be given to Caterpillar's amendment of a long-standing licencing agreement(s) that had been in place for close to 30 years with its manufacturing subsidiaries in Belgium and France. Amendments agreed to in 1990 suspended the subsidiaries' obligations to remit the required 5% of revenues ( net sales less direct costs) under the licensing contracts until the subsidiaries were once again profitable.
The licensing agreements covered the use by the foreign subsidiaries of groups of intangibles including Caterpillar patents, manufacturing methods, trademarks and copyrighted materials. The amended licensing agreements suspended the royalty payments during year in which the subsidiaries incurrred net operating losses and further allowed the carryover of NOLs to reduce required payments in subsequent years. During the years in issue, the subsidiaries incurred losses, and therefore, under the 1990 amendments, made no royalty payments which in turn would result in Caterpillar's not reporting any licensing income in such year.
The Internal Revenue Service regarded the amendments and therefore the suspension of royalty payments , as not reflectived of the arms' length standard that is the central feature of Section 482 and the underlying regulations. It therefore wanted Catperillar to be treated as having received the required royalties under the orginial royalty agreements. The petitioner-corporation countered by claiming that suspending the royalties for loss years was still reflective of arms' length pricing since the business purpose was to help restore the profitability of Caterpillar's foreign manufacturing operations.
Prior to the Tax Court litigation, in 2000 Caterpillar Inc. filed for relief under the competent authority provisions of the U.S. income tax conventions with France and Germany. No agreement was reached. In 2005 Caterpillar challenged the assessment (proposed) with IRS Appeals but its efforts were similarly rejected.
In an earlier stipulation filed with the Tax Court in February, 2014, Caterpillar and the Internal Revenue Service agreed to increase Caterpillar's income by $22 million with respect to the operations of the Belgian subsidiary and by $11 million for income as to its French subsidiary.
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