expended on Avitene's manufacturing process. P-PR claimed
on its 1992 Federal income tax return that it was entitled to
a $1,993,264 Puerto Rico and possession tax credit under sec.
936(a), I.R.C. Ps argue that P-PR met the "active conduct of
a trade or business within a [U.S.] possession" requirement of
sec. 936(a)(2)(B), I.R.C., by virtue of: (1) A's activities in
Puerto Rico, (2) the fact that A manufactured Avitene using
P-PR's raw materials and equipment, (3) the fact that P-PR
continued to own the raw materials from the time that it
received them until the time that it sold them in their manu-
factured form as Avitene, and (4) the fact that P-PT, paid P-
USA and A for the cost of their labor connected to the Avitene
manufacturing process. Held, P-PR did not actively conduct a
trade or business in Puerto Rico as required by sec.
936(a)(2)(B), I.R.C.; i.e., P-PR did not participate regularly,
continually, extensively, and actively in the management and
operation of a profit-motivated activity in that possession.

David A. Hickerson, for petitioners.

Theodore J. Kletnick, Alan S. Kline, George Curran, Jennifer Allan Kassabian, Marie E. Small, and Melanie A. Garger, for respondent.

OPINION

LARO, Judge: These consolidated cases were submitted to the Court without trial. See Rule 122. Respondent determined an $815,196 deficiency in the Federal income tax of MedChem (P.R.), Inc. (MedChem P.R.), for its taxable year ended August 31, 1992. Respondent determined a $1,705,019 deficiency in the Federal income tax of MedChem Products, Inc., & Subsidiaries (MedChem Group) for its taxable year ended August 31, 1992. Following concessions, we must decide whether MedChem P.R. meets the "active conduct of a trade or business within a possession" requirement of section 936(a)(2)(B). We hold it does not.1 Unless otherwise indicated, section references are to the Internal Revenue Code applicable to the relevant years. Rule references are to the Tax Court Rules of Practice and Procedure. We attach hereto as appendix A a summary of some of the critical events that occurred during: (1) The 202-month period from December 18, 1987, to August 31, 1989, that preceded the 3year test period relating to our determination under section

1 Given that holding, we need not and do not decide the parties' other dispute; to wit, whether MedChem P.R. manufactures or produces a product in the possession as required by sec. 954(d)(1)(A).

936(a)(2)(B), (2) the 3-year test period from September 1, 1989, to August 31, 1992, and (3) the 20-month period from August 31, 1992, to April 1994 that followed the 3-year test period.2

Background

The parties have filed with the Court a stipulation of facts and certain related exhibits. We incorporate herein by reference the stipulated facts and exhibits. We find the stipulated facts accordingly, and we set forth the relevant facts in this background section.

MedChem Products, Inc. (MedChem U.S.A.), is a Massachusetts corporation whose principal place of business is in Woburn, Massachusetts (Woburn). MedChem U.S.A. succeeded MedChem P.R. following the subject years through a merger of the latter into the former. MedChem P.R. was incorporated in Delaware on December 8, 1987, as MedChem Puerto Rico, Inc., it changed its name on December 22, 1987, to BioChem Products, Inc., it changed its State of incorporation on March 1, 1992, to Massachusetts, and it changed its name on November 25, 1992, to MedChem P.R. Med Chem P.R. and its predecessors (each hereinafter referred to as MedChem P.R.) were always wholly owned subsidiaries of MedChem U.S.A.

The original books and records of MedChem P.R. and MedChem U.S.A. are maintained in Woburn on an accrual method of accounting and on the basis of a fiscal year ending on August 31. During each of MedChem P.R.'s taxable years ended on August 31, 1990, 1991, and 1992, all of its reported income was "intangible property income", sec. 936(h)(3), attributable to the sale of Avitene, a pharmaceutical manufactured in Puerto Rico by Alcon Puerto Rico, Inc. (Alcon P.R.), an unrelated entity. Avitene is a blood clotting drug that is manufactured from the interior collagen-rich lining (corium) of cowhides. It is used during surgery to control bleeding. It was primarily manufactured by Alcon P.R. dur

2 We take into account petitioners' actions in years subsequent to their 1992 taxable year to evaluate their prospects during their 1992 year. See Levin v. Commissioner, 832 F.2d 403, 406 n.3 (7th Cir. 1987) (Tax Court allowed to rely on subsequent events to determine whether those events were consistent with the Court's judgment of the facts available in the year in issue), affg. 87 T.C. 698 (1986).

ing the relevant years in the forms of 35x70 mm. nonwoven web and 1 gram finished flour.

MedChem U.S.A. leases office, research, and manufacturing facilities in Woburn. It leased 32,000 square feet in 1989, and its 63 full-time employees on August 31, 1991, worked in that space. On August 31, 1992, MedChem U.S.A. leased approximately 50,000 square feet at two facilities in Woburn. MedChem U.S.A.'s 144 full-time employees on August 31, 1992, worked at MedChem U.S.A.'s manufacturing facilities in Woburn and San Antonio, Texas.

The individuals who were connected with the Avitene manufacturing and sales business (Avitene business) were employed by MedChem U.S.A., MedChem P.R., Alcon P.R., or Kelly Services, Inc. (Kelly), a supplier of temporary labor. Each MedChem U.S.A. employee connected with Avitene was paid by MedChem U.S.A. and had his or her office at MedChem U.S.A.'s facility in Woburn. MedChem P.R. had no employees after June 30, 1990. MedChem P.R.'s only employee before July 1, 1990, was Jose Perez, and MedChem P.R. terminated him on June 30, 1990. Nor did any of MedChem P.R.'s officers or directors have an office in Puerto Rico after June 30, 1990. All of MedChem P.R.'s officers and directors, except Mr. Perez, were officers and/or directors of MedChem U.S.A., and, after June 30, 1990, none of MedChem P.R.'s officers or directors was paid by MedChem P.R.

The individuals connected with the Avitene business are listed below by name, affiliate, office location, position, and period of affiliation in the listed capacity.