(1994) Seagate Technology, Inc. And
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SEAGATE TECH., INC. v. COMMISSIONER Docket No. 11660-90. 102 T.C. 149 (1994) SEAGATE TECHNOLOGY, INC. AND CONSOLIDATED SUBSIDIARIES, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT United States Tax Court. Filed February 8, 1994. Attorney(s) appearing for the Case Joel V. Williamson, William A. Schmalzl, Joseph R. Goeke, John Bleveans, Thomas C. Durham, Roger J. Jones, M. Ellen Robb, Clisson S. Rexford, and Scott M. Stewart, for petitioner. William E. Bonano, John O. Kent, Christopher J. Croudace, Christopher J. Faiferlick, and Paul G. Robeck, for respondent. C O N T E N T S Page STATEMENT OF ISSUES 156 I. GENERAL FINDINGS OF FACT 157 A. Background in General 157 B. The Industry in General 158 C. Seagate Scotts Valley 159 D. Seagate Singapore 160 II. ISSUE 1: WHETHER RESPONDENT'S REALLOCATIONS OF GROSS INCOME UNDER SECTION 482 ARE ARBITRARY, CAPRICIOUS, AND UNREASONABLE 161 A. FINDINGS OF FACT 161 1. The Notices of Deficiency 161 2. Respondent's Expert Reports 162 B. OPINION 163 1. The Parties' Positions 163 2. Section 482 in General 163 III. ISSUE 2: WHETHER RESPONDENT SHOULD BEAR THE BURDEN OF PROOF FOR ANY OF THE ISSUES INVOLVED IN THE INSTANT CASE 165 A. FINDINGS OF FACT 165 1. The Notices of Deficiency 165 2. Respondent's Concessions 167 3. Respondent's Experts 167 B. OPINION 168 1. The Parties' Positions 168 2. The Court's Holding as to the Burden of Proof 169 IV. ISSUE 3: WHETHER SEAGATE SCOTTS VALLEY PAID SEAGATE SINGAPORE ARM'S-LENGTH PRICES FOR COMPONENT PARTS 172 A. FINDINGS OF FACT 172 1. In General 172 2. Intercompany Transactions 172 3. Component Parts Manufacturing 173 4. Respondent's Notices of Deficiency 176 5. Petitioner's Experts 176 a. Daniel P. Broadhurst 176 b. Gary E. Holdren 177 c. Clark J. Chandler 177 6. Respondent's Experts 181 a. Thomas Horst 181 b. Grant M. Clowery 182 c. Steven M. Zemsky 184 7. Other Third Party Transactions 184 B. OPINION 185 1. Ultimate Findings of Fact 185 2. The Methods 185 a. The Comparable Uncontrolled Price (CUP) Method 186 i. The CUP Method in General 186 ii. The Parties' Positions on the CUP Method and the Court's Holding as to Its Application 187 b. The Cost-Plus Method 188 i. The Cost-Plus Method in General 188 ii. The Parties' Positions on the Cost-Plus Method as Applied by Dr. Horst and the Court's Ruling as to That Method 189 iii. The Parties' Positions on Applying the Cost-Plus Method Using the Bull Peripheriques Sale and the Court's Holding as to That Method 193 iv. The Parties' Position on Applying the Cost-Plus Method Using Dr. Chandler's Approaches and the Court's Holding as to That Method 194 c. The Court's Holding as to the Arm's-Length Transfer Price for Component Parts Sold to Seagate Scotts Valley 195 V. ISSUE 4: WHETHER SEAGATE SCOTTS VALLEY PAID SEAGATE SINGAPORE AN ARM'S-LENGTH PRICE FOR COMPLETED DISK DRIVES SEAGATE SINGAPORE PRODUCED AND SOLD TO SEAGATE SCOTTS VALLEY 196 A. FINDINGS OF FACT 196 1. Disk Drive Manufacturing and Sales 196 2. Respondent's Notices of Deficiency 201 3. Petitioner's Experts 203 a. Mr. Holdren 203 b. Mr. Broadhurst 213 4. Respondent's Experts 217 a. Dr. Clowery 217 b. Dr. Frisch 220 B. OPINION 225 1. Ultimate Findings of Fact 225 2. Analysis of Completed Disk Drive Issue 225 a. The CUP Method 226 i. Petitioner's Position 226 ii. Respondent's Position 227 iii. The Court's Holding as to the CUP Method 228 b. The Resale Price Method 231 i. Respondent's Resale Price Method 233 ii. The Court's Holding as to Respondent's Resale Price Method 235 iii. Petitioner's Resale Price Method 236 iv. The Court's Holding as to Petitioner's Resale Price Method 238 c. The Court's Holding as to the Arm's-Length Transfer f d. The Price Allowance and Allowance for Seagate Singapore's Marketing Activities Allowed by Respondent in the Notices of Deficiency 240 i. The Price Allowance 240 ii. The "Offset" for Seagate Singapore's Marketing Activities 241 VI. ISSUES 5 AND 6: WHETHER SEAGATE SINGAPORE PAID SEAGATE SCOTTS VALLEY ARM'S-LENGTH ROYALTIES FOR THE USE OF CERTAIN INTANGIBLES AND WHETHER THE ROYALTY FEE SEAGATE SINGAPORE PAID SEAGATE SCOTTS VALLEY FOR DISK DRIVES COVERED UNDER A SECTION 367 PRIVATE LETTER RULING APPLIES TO ALL SUCH DISK DRIVES SHIPPED TO THE UNITED STATES, REGARDLESS OF WHERE TITLE PASSED 241 A. FINDINGS OF FACT 242 1. General Background Information 242 2. Seagate Scotts Valley and Seagate Singapore Agreements 243 a. The Property Transfer Agreement 243 b. The Royalty Agreement 245 c. The Marketing Agreement 246 3. The Ruling Request and Private Letter Ruling 247 a. The Request 247 b. The Private Letter Ruling 248 4. Royalties Paid 249 5. Third Party Licensing Agreements 249 a. Co. R and Co. S 249 b. Texas Instruments, Inc 250 c. Honeywell Bull 251 d. TEAC Corp 251 e. Co. K 252 f. Co. L 252 g. Co. M 253 h. IBM 253 i. Co. N 253 j. Co. B and Co. C Agreement 254 k. LaPine Technology Corp. and Kyocera Corp. Agreements 255 i. The Research and Development Agreement 256 ii. The Trading Agreement 256 iii. The Technology Transfer and Manufacturing Agreement 257 l. Co. B and Co. F Agreement 258 m. Co. P and Co. Q Agreement 259 n. Co. D and Co. E Agreement 259 o. Co. G and Cos. H and J Agreement 260 6. Respondent's Notices of Deficiency 261 7. The Experts' Positions 262 a. Petitioner's Experts 262 i. Dr. Chandler 262 ii. James Patterson 263 iii. Zoltan M. Mihaly 264 iv. Paul M. Enlow 265 v. Mr. Holdren 265 vi. Mr. Broadhurst 266 b. Respondent's Experts 266 i. Dr. Horst 266 ii. Anthony LaPine 268 iii. Mark R. Sherwood 270 iv. Harold J. McLaughlin 271 v. George E. Frost 271 B. OPINION 273 1. Analysis of Arm's-Length Royalties for Use of Intangibles 273 a. The Regulations in General 273 b. The Parties' Positions 274 i. Respondent's Position 274 ii. Petitioner's Position 275 c. The Court's Holding as to the Arm's-Length Royalty Rate 278 d. The Offset for the Marketing Commissions Paid by Seagate Singapore to Seagate Scotts Valley 282 2. Analysis of Scope of Ruling 284 VII. ISSUE 7: WHETHER THE PROCUREMENT SERVICES FEES SEAGATE SINGAPORE PAID SEAGATE SCOTTS VALLEY G A. FINDINGS OF FACT 290 1. Background 290 a. The Services Agreement 290 b. Procurement Services Performed by Seagate Scotts Valley for Seagate Singapore 291 c. Seagate Singapore's Procurement Activities 292 d. Solarise Enterprises, Inc 293 2. Respondent's Notices of Deficiency 294 3. The Experts' Positions 295 a. Petitioner's Expert—Dr. Chandler 295 b. Respondent's Experts 296 i. Martin Ehrlich 296 ii. Dr. Clowery 297 B. OPINION 298 1. The Burden of Proof 298 2. The Services Regulations 299 3. The Parties' Positions 301 a. Petitioner's Position 301 b. Respondent's Position 303 c. The Court's Holding as to the Arm's-Length Procurement Services Fee 303 VIII. ISSUE 8: WHETHER THE CONSIDERATION SEAGATE SINGAPORE PAID SEAGATE SCOTTS VALLEY PURSUANT TO A COST-SHARING AGREEMENT WAS ARM'S LENGTH 305 A. FINDINGS OF FACT 305 1. Background 305 2. The Research and Development Cost-Sharing Agreement 306 3. Payments Under the Cost-Sharing Agreement 306 4. The Experts' Opinions 307 a. Petitioner's Expert—Dr. Chandler 307 b. Respondent's Experts 309 i. Dr. Horst 309 ii. Dr. Clowery 309 iii. Dr. Chandler's Critique of Dr. Horst's and Dr. Clowery's Method 310 B. OPINION 311 1. The Cost-Sharing Regulations 311 2. The Parties' Positions 311 a. Petitioner's Position 311 b. Respondent's Position 312 3. The Court's Holding as to the Arm's-Length Share of the Research and Development Costs 312 IX. ISSUE 9: WHETHER SEAGATE SCOTTS VALLEY IS ENTITLED TO OFFSETS FOR WARRANTY PAYMENTS SEAGATE SINGAPORE PAID TO SEAGATE SCOTTS VALLEY 314 A. FINDINGS OF FACT 314 1. Background 314 2. Respondent's Notices of Deficiency 315 B. OPINION 315 1. The Parties' Positions 315 a. Petitioner's Position 315 b. Respondent's Position 316 2. The Court's Holding as to the Warranty Offset 316 X. PROCEDURAL MATTERS 317 A. Petitioner's Motion To Exclude Part IV of Dr. Clowery's Report 317 1. Background 317 2. Ruling on Exclusion of Part IV of Dr. Clowery's Report 320 B. Petitioner's Motion To Exclude Certain Documents 321 WELLS, Judge: Respondent determined deficiencies in petitioner's consolidated corporate Federal income tax as shown by the following chart: TYE Deficiency June 30, 1981 ............................. $85,826 June 30, 1983 ............................. 51,510 June 30, 1984 ............................. 23,483,054 June 30, 1985 ............................. 73,420 June 30, 1986 ............................. 12,801,009 June 30, 1987 ............................. 75,785,217 All section references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure unless otherwise indicated. S TAT E M E N T O F I S S U E S In the instant case, we are asked to decide several distinct transfer pricing issues arising out of adjustments determined by respondent under section 482. Following concessions by the parties, the issues for decision are as follows: 1. Whether respondent's reallocations of gross income under section 482 for the years in issue are arbitrary, capricious, or unreasonable; 2.