Procter & Gamble Co. v. Commissioner of Internal Revenue

A United States corporation, Procter & Gamble Company (P&G) (plaintiff), had a wholly owned Swiss subsidiary, Procter & Gamble A.G. (AG). AG marketed P&G products in some other countries. Under a package-fee licensing agreement, AG paid a royalty to P&G for the use of P&G’s technology based on AG’s net sales of P&G products. AG had similar agreements with its subsidiaries. In 1967, P&G sought to offer its products in Spain. Spain regulated foreign investment, criminalizing payments from Spanish entities to residents of other countries without governmental authorization. Some limited foreign investment could be authorized. P&G applied to create Procter & Gamble Espana S.A. (Espana). P&G’s application stated that Espana would need several million pesetas annually for royalty and technical-assistance payments. In 1968, Spain approved P&G’s application but barred Espana from paying any amount for royalties or technical assistance. Espana was organized as a wholly owned subsidiary of AG. In 1970, another authorization letter barred Espana from paying royalties or for technical assistance without approval. A 1973 decree allowed payment of royalties by a Spanish entity only if foreign investors held less than 50 percent. A 1976 decree disallowed payments by Spanish entities to foreign investors for technology transfers. Spain occasionally authorized Espana to pay P&G for engineering services, stipulating that these were neither royalties nor payments for technical assistance. In 1985, Spain relaxed its regulations and removed the limits on Espana’s royalty payments in 1987. Internal Revenue Code § 482 enabled the commissioner of Internal Revenue (commissioner) (defendant) to reallocate income across organizations controlled by the same interest to prevent tax evasion or avoidance. The commissioner ruled that AG’s income for 1978 and 1979 should have included royalties from Espana. The commissioner asked P&G for additional tax payments of about $1.2 million for 1978 and $1.8 million for 1979. Upon P&G’s request for review, the Tax Court held that because Spanish law barred royalty payments, P&G did not owe additional tax. The commissioner argued that Espana could have paid dividends and that the blocked-income Treasury regulation allowed P&G to treat payments temporarily barred by a foreign country as deferred income and to liquidate Espana.