Rev. Rul. 65-142

Reconsideration has been given to the acquiescence of the Commissioner of Internal Revenue in the decision of the Tax Court of the United States in the case of The Lake Erie and Pittsburg Railway Company v. Commissioner , 5 T.C. 558 (1945), acquiescence, C.B. 1945, 5.

The Lake Erie case holds that section 45 of the Internal Revenue Code of 1939 is not applicable where two corporations, having different stockholders, deal with a third corporation owned equally by them under agreements providing the terms and conditions for dealings between the two corporations and the third corporation.

Section 482 of the Internal Revenue Code of 1954 contains the provisions previously contained in section 45 of the 1939 Code allowing the Secretary of the Treasury or his delegate to distribute, apportionS or allocate gross income, deductions, credits, or allowances between or among two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, where such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.

The court in the Lake Erie case narrowly construed the section to exclude from its provisions two corporations, each with 50 percent formal voting control, and their jointly owned subsidiary, even though the two corporations were acting in concert, joined by a common interest, and by explicit agreements detailing the terms and conditions under which they were to deal with their joint subsidiary. This holding is considered erroneous for a number of reasons. The court's interpretation of control by the same interests is inconsistent with the broad language of the section (that is, with such words as `whether or not incorporated,' `whether or not affiliated,' `owned or controlled directly or indirectly') and with the Income Tax Regulations thereunder, and disregards the realities of the arrangement. Compare Jesse E. Hall v. Commissioner , 32 T.C. 390 (1959), affirmed, 294 Fed.(2d) 82. Viewed realistically, the New York Central and the Pennsylvania Railroads in the Lake Erie case were not unrelated corporations acting separately but, rather were acting together, joined by a common interest and explicit agreements. For purposes of section 45 of the 1939 Code or section 482 of the 1954 Code, the reality of control by the same interests is present no less than if they had formed a partnership ( Forcum-James Company v. Commissioner , 7 T.C. 1195 (1946), acquiescence, C.B. 1948-1, 2, reversed and remanded pursuant to stipulation, 176 Fed.(2d) 311), to deal with petitioner or had formed another corporation to deal with petitioner ( Asiatic Petroleum Company (Delaware) Ltd. v. Commissioner , 79 Fed.(2d) 234 (1935), Ct. D. 1105, C.B. XV-1, 181 (1935), certiorari denied, 296 U.S. 645 (1935)).

The Lake Erie decision is contrary to the trend of recent decisions which stress the realities of common control. Thus, in Advance Machinery Exchange, Incorporated v. Commissioner , Tax Court Memorandum opinion entered January 25, 1945, affirmed, 196 Fed.(2d) 1006 (1952), certiorari deied, 344 U.S. 835 (1952), the common business interests of a father and son were related together and all the income placed in one of the corporations set up to handle their business. In Grenada Industries, Inc., et al. v. Commissioner , 17 T.C. 231 (1951), acquiescence in part, C.B. 1952-2, 2, and nonacquiescence in part, C.B. 1952-2, 5, affirmed, 202 Fed.(2d) 873 (1953), certiorari denied, 346 U.S. 819 (1953), transactions between a partnership and a related corporation were held subject to section 482 of the 1954 Code. Even though record ownership of various stocks and partnership interests were scattered among various persons and trusts, the court did not require preponderance of ownership of any one source but looked realistically at the facts of actual control.

Such a realistic construction of section 482 of the Code is particularly important to the proper administration of the tax laws in the foreign or international area. In that area, section 482 of the 1954 Code is one of the basic tools the Commissioner has to prevent income from being shifted beyond United States tax jurisdiction. A domestic corporation attempting to shift income to its wholly-owned foreign subsidiaries (by improper pricing, for example) falls within the coverage of section 482 of the 1954 Code. However, if two or more domestic corporation (with a common desire to avoid United States tax by shifting income to a foreign corporation) organize a commonly owned subsidiary and deal with it directly pursuant to carefully spelled out terms and conditions, they would avoid section 482 of the 1954 Code if the reasoning in the Lake Erie case were extended to them, even though the result is to accomplish the same income shifting they would accomplish if each dealt with a separate and wholly-owned subsidiary.

In view of the foregoing, the prior acquiescence in The Lake Erie and Pittsburg Railway Company v. Commissioner , 5 T.C. 55, (1945), C.B. 1945, 5, has been withdrawn and nonacquiescence has been substituted therefor.

¹ Also released as Technical Information Release 726, dated May 5, 1965.