DHL Corporation and Subsidiaries v. Commissioner of Internal Revenue

DHL Corporation (plaintiff) (DHL) was a package-delivery company that began in California in 1969. Three years later, Document Handling Limited, International (DHLI) was incorporated in Hong Kong. International DHL deliveries were mostly handled by local agents. Middleton N.V. (MNV) was incorporated in 1979 and owned most of the overseas operating companies. Common control of the three entities is conceded. DHL handled American shipments, and DHLI handled foreign shipments. DHL had exclusive rights to use the DHL trademark in the United States, and DHLI had similar rights in foreign commerce. In the late 1980s, DHL and DHLI negotiated concerning a possible sale. Ultimately, a consortium of three foreign investors (the consortium) agreed to purchase a majority of DHLI/MNV, a small portion of DHL, and an option to purchase the DHL trademark for $20 million. In initial negotiations, DHLI/MNV was to be sold for $450 million (consistent with the final terms), whereas the trademark was selling for $50 million. In essence, during the interim, a Coopers & Lybrand report had recommended that, given DHL’s taxation situation, a lower valuation would be recommended. DHL sought out a comfort letter from Bain & Co. that supported a $20 million trademark valuation, which was obtained. After the sale, the Commissioner of Internal Revenue (the commissioner) (defendant) found a deficiency. The economist who analyzed the case undertook the first trademark valuation and found it to be $600 million, with a total alleged deficiency of $194,534,167 and another $74,777,222 in penalties. DHL and subsidiaries filed suit in the tax court, which ultimately imposed a $100 million valuation, with $50 million for domestic rights and $50 million for overseas trademark rights, but upheld the allocation of income to DHL for the undervaluing of the trademark. The total deficiencies and penalties were then $59,427,093. However, DHL appealed, arguing that the trademark valuation was clear error and that DHLI had actively participated in the development of the trademark, so the allocation was also error. On the first prong, DHL argued that the Bain & Co. valuation and the presence of a nonrelated party (the consortium) established an arm’s-length transaction. DHL also argued that the allocation was erroneous because DHLI bore the cost and risk of developing the DHLI trademark.