United States Steel Corp v.

United States Steel Corp v. Commissioner In United States Steel Corporation v. Commissioner, the court was called upon to determine that appropriate way of allocating additional income to a corporation with wholly-held foreign subsidiaries. This is a critical question, particularly in a global economy, when businesses may have dual motives for the creation of wholly-owned subsidiaries, and the reduction or avoidance of taxes may be among the taxpayer's legitimate goals in forming those corporations.

Petitioner United States Steel Corporation, the world's largest producer of steel, wanted a way to develop iron ore found in Bolivar, Venezuela and transport it to the United States for processing into steel. United States Steel Corporation organized Orinoco Mining Company, a Delaware Corporation, to develop the deposits, and then Navios Corporation, a Liberian shipping company, to transport the steel. The mining company and the shipping company were wholly owned subsidiaries of the United States Steel Corporation.

The petitioner established a price for the ore, which is the price that the ore would be sold to any and all producers of steel either in the United States or in other countries. Navios enabled the petitioner to provide for the transportation of the ore from Venezuela to United States ports, as well as to foreign buyers, without the income from it having to be taxes in Venezuela or the United States.

The court found that the decision to divorce the shipping operations from the mining operations was a good business decision, which should not be questioned simply because it can allow for the avoidance of United States income taxes. In United States Steel Corp. v. Commissioner, it states petitioner organized Navios Corporation, a Liberian shipping company, for the purpose of transporting the ore from the mine site to the petitioner's steel mills in the United States.

Liberia has long been known as a tax haven jurisdiction, and has been used extensively as a place for incorporating ship-owning corporations. The Petitioner had several other possible alternatives that the petitioner could have used to incorporate its ship-owning corporations. The petitioner could have chosen to use another country for incorporation to avoid paying taxes for the shipping.

Commonly known as a flag of convenience, it is not unusual for to incorporate a shipping company in a foreign jurisdiction in order to avoid paying taxes on items shipped through that company. Liberia is the most common company used in flag of convenience registries. However, there are a number of other countries that offer similar tax benefits for shipping companies that are incorporated in those countries, and three of these countries are Panama, the British Virgin Islands and the Isle of Man.

Furthermore, in the case, it is also stated that, "There could be no independent transactions with unrelated parties under the same or similar circumstances" within the meaning of section 1.482-1(d) (3) of the regulations. I would interpret this statement to mean that the court disagreed with the Petitioner's contention that Navios was charging an appropriate arm's length rate for its shipping.

The Petitioner was able to demonstrate that unrelated steel producers did pay Navios the same rates as petitioner, and that the petitioner did in fact pay an unrelated carrier of iron ore more than it paid Navior for transportation from Chile to the United States. However, the Tax Commissioner was able to demonstrate that a subsidiary corporation of Bethlehem Steel Corporation, the largest independent purchaser of Venezuelan ore from Orinoco, did not use Navios for transport.

The assumption is that the Bethlehem subsidiary was able to find someone who would do the shipping for less. In addition, Petitioner attempted to demonstrate that Navios had similar rates to the going rates in the charter business. However, the court found that there were no published charter rates for ore carriers of any significant during the years in question; instead, the rates proffered by the Petitioner were very condition-dependent and were not sufficient evidence of what would be a reasonable charge for continuous shipping of the ore.

The court determined that there simply was not a comparable rate, because the level of shipping that Navios did for U.S. Steel did not have a precedent. 26 C.F.R. § 1.482-1(d)(3) details what factors are used in determining comparability. Under 26 C.F.R. § 1.482(d)(3)(i): Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the functions performed, and associated resources employed, by the taxpayers in each transaction.

This comparison is based on a functional analysis that identifies and compares the economically significant activities undertaken, or to be undertaken, by the taxpayers in both controlled and uncontrolled transactions. A functional analysis should also include consideration of the resources that are employed, or to be employed, in conjunction with the activities undertaken, including consideration of the type of assets used, such as plant and equipment, or the use of valuable intangibles.

A functional analysis is not a pricing method and does not itself determine the arm's length result for the controlled transaction under review.

Functions that may need to be accounted for in determining the comparability of two transactions include -- (a) Research and development; (B) Product design and engineering; (C) Manufacturing, production and process engineering; (D) Product fabrication, extraction, and assembly; (E) Purchasing and materials management; (F) Marketing and distribution functions, including inventory management, warranty administration, and advertising activities; (G) Transportation and warehousing; and (H) Managerial, legal, accounting and finance, credit and collection, training, and personnel management services (26 C.F.R. § 1.482(d)(3)(i)). Furthermore, under 26 C.F.R.

§ 1.482(d)(3)(ii): Determining the degree of comparability between the controlled and noncontrolled transactions requires a comparison of the significant contractual terms that could affect the results of the two transactions.

These terms include -- (1) the form of consideration charged or paid; (2) Sales or purchase volume; (3) the scope and terms of warranties provided; (4) Rights to updates, revisions or modifications; (5) the duration of relevant license, contract or other agreements, and termination or renegotiation rights; (6) Collateral transactions or ongoing business relationships between the buyer and the seller, including arrangements for the provision of ancillary or subsidiary services; and (7) Extension of credit and payment terms (26 C.F.R. § 1.482(d)(3)(ii)). In other words, making a comparison of compatibility under 26 C.F.R.

§ 1.482(d)(3) involves an actual examination of whether Determine which sections of section 1.482-1(d)(3) would likely be cited the most often. It seems clear that contract terms are going to be cited very frequently as a basis of comparison, most specifically the form of consideration charged or paid. Is the company actually paying a controlled subsidiary the same amount that it would have to pay a non-controlled competitor? That question speaks to the whole essence of comparability.

The next consideration under contracts is also critical in helping determine the actual cost in many scenarios, and that is whether the sales or purchase volume in the contract with a controlled subsidiary is comparable to the volume in an agreement with a noncontrolled company. There is an expectation that any type of large-volume business is going to result in some type of volume discount, so that it is not comparable to compare, for example, the retail price of one item with the wholesale cost of 1,000 items.

Furthermore, one has to consider other transactions or business relationships between the parties when trying to determine comparability; a noncontrolled subsidiary might have 10 comparable contracts, but if all of those contracts are with the same business, indicating 10 times the volume, it would not be fair or accurate to consider those contracts comparable. In a non-contract, more functional perspective, it is difficult to suggest which factors will be used most frequently, because that is going to greatly depend on the underlying industries being examined.

However, in this instance, where the question of comparability revolves around mining and shipping, clearly the product fabrication, extraction and assembly and transportation and warehousing functions would receive the highest level of scrutiny. In Hospital Corp. Of America v. Commissioner, 81 T.C. 520 (1983) (nonacq.), Hospital Corp. Of America (HCA) was charged with avoiding taxes. It was a U.S. corporation engaged in hospital management and operated hospitals through a series of U.S. And foreign subsidiaries, including one in the Cayman Islands, which operated a facility in Saudi Arabia.

Because the receipts went to the Cayman Corporation, they were not taxable by the U.S. The IRS argued that the Cayman Corporation should have been completely disregarded because HCA provided technology and performed services for the Cayman Corporation. The court did allow for an adjustment based on an arm's length standard for the provision of services and technology, but did not allow for the disregarding of the corporation.

In this scenario, I would argue that the company had met the standards of the limited safe haven under the services cost method (SCM). Under the SCM, the arm's length standard is satisfied when the relevant price is at least equal to the total cost of providing the services. There does not appear to be evidence that HCA provided more services than it was compensated for by the Cayman Corporation. Therefore, it meets the threshold requirement for limited safe haven.

Moreover, the provision of medical services appears to fall under the qualifications of the SCM that services be a controlled service transaction or a group of transactions. This provision of services is not one of the prohibited services including manufacturing, production, extraction of mineral resources, construction, reselling, research and development, engineering, financial, or insurance. In United Parcel Service of America, Inc. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001), the plan seemed designed for the purposes of tax evasion.

UPS sought to shift income to a wholly owned subsidiary in Bermuda through the purchase of insurance on excess value charges for parcels with a value greater than $100. UPS distributed shares of the Bermuda subsidiary (OPL) as a taxable dividend to UPS shareholders. UPS then purchased an insurance policy for its customers from National Union, which then entered into a reinsurance contract with OPL. In other words, National Union served as a pass-through for OPL.

The court determined that the transaction was not a sham because National Union and UPS had genuine contractual obligations to one another as did OPL and National Union. The limited safe haven option would not be available in this scenario because it is specifically prohibited when the purpose of the subsidiary corporation is to provide reinsurance. However, there was a real contractual obligation between UPS and National Union, which was recognized by the tax court.

I would need more information about the ownership of National Union to understand why it would function as a straw man for UPS and OPL, because the conditions, as stated, which is that National Union paid all of its fees to OPL means that National Union made no profit off of its transaction. If it did not profit from the transaction, it would be difficult to make any type of comparability argument. In the GAC produce scenario, GAC was one of several companies in Mexico and the United States owned.