REPORTS

OF THE

UNITED STATES TAX COURT

THE COCA-COLA COMPANY, AND INCLUDIBLE SUBSIDIARIES, PETITIONER v. COMMISSIONER OF INTERNAL

REVENUE, RESPONDENT

Docket No. 299-94.

Filed January 4, 1996.

P filed a motion for partial summary judgment relating to the computation of combined taxable income under sec. 936(h)(5)(C)(ii), I.R.C., with respect to syrup and soft-drink concentrate produced by P's sec. 936, I.R.C., subsidiary, Caribbean Refrescos, Inc.

1. Held, sec. 1.936-6(b)(1), Q&A-12, Income Tax Regs., governs the computation of combined taxable income with respect to sales of component concentrate to unrelated third parties.

2. Held, further, sec. 1.936-6(b)(1), Q&A-12, Income Tax Regs., requires U.S. affiliate expenses to be allocated and apportioned to the component concentrate by applying the production cost ratio to all expenses allocable and apportionable to the integrated product; i.e., bottle and can soft drink.

3. Held further, sec. 1.936-6(b)(1), Q&A-12, Income Tax Regs., requires U.S. affiliate expenses allocable and apportionable to the integrated product, i.e., bottle and can soft drink, to be determined under sec. 1.861-8, Income Tax Regs., as described in sec. 1.936-6(b)(1), Q&A-1, Income Tax Regs.

4. Held, further, P may net interest income against interest expense in determining the amount of the interest deduction to be allocated and apportioned in computing combined taxable income under sec. 936, I.R.C., and sec. 1.861-8(e)(2), Income Tax Regs. Bowater Inc. v. Commissioner, 101 T.C. 207 (1993).

1

Charles W. Hall, William S. Lee, Nancy T. Bowen, William P. McClure, Herman B. Bouma, and Gregory J. Ossi, for petitioner.

Beth Williams, H. Steven New, and David P. Fuller, for respondent.

OPINION

WRIGHT, Judge: This matter is before the Court on petitioner's motion for partial summary judgment filed under Rule 121.1 This case was heard at a motions session held on February 23, 1995, at Washington, D.C.2 Petitioner's motion was taken under advisement.

Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Florida Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). Summary judgment may be granted with respect to all or any part of the legal issues in controversy "if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner, 90 T.C. 753, 754 (1988). The moving party bears the burden of proving that there is no genuine issue of material fact, and factual inferences will be read in a manner most favorable to the party opposing summary judgment. Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985). The facts presented below do not appear to be in dispute, are stated solely for purposes of deciding the motion, and are not findings of fact for this case. Fed. R. Civ. P. 52(a); Sundstrand Corp v. Commissioner, supra at 520.

I. Background

Petitioner owns bottling companies known as company bottling operations (CBO's), each of which is a domestic corporation owned or controlled directly or indirectly by petitioner. Petitioner's principal place of business is Atlanta, Georgia.

1 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect during the years in issue.

2 In addition, the Court considered an amicus curiae brief filed by PepsiCo.

Caribbean Refrescos, Inc. (CRI), is a wholly owned subsidiary of petitioner.

CRI produces soft-drink concentrate in Puerto Rico and transfers all of the concentrate for the U.S. market to CocaCola USA (sometimes referred to as USA), an unincorporated division of petitioner. Coca-Cola USA sells concentrate, in unchanged form, to CBO's and to unrelated independent bottling companies engaged in producing syrup and selling such syrup to wholesalers. Coca-Cola USA converts the remainder of the concentrate into fountain syrup and sells the syrup to unrelated bottlers and CBO's. Fountain syrup is a combination of concentrate, high fructose corn syrup, and water. Syrup is mixed with carbonated water at retail outlets to produce the fountain soft drink sold to consumers. During the years at issue, the dilution ratio for Coke, Diet Coke, Caffeine Free Diet Coke, Cherry Coke, and Diet Cherry Coke was 1:79.26:515. Thus, one unit of concentrate is processed into 79.26 gallons of syrup, which is further processed into 515 gallons of soft drink. Regardless of the form of the product sold, each sale involves exactly one unit of concentrate. The CBO's that purchase concentrate from Coca-Cola USA convert the concentrate into fountain syrup and sell the syrup to unrelated retailers. The CBO's that purchase fountain syrup sell the fountain syrup to unrelated retailers.

CRI is both the possessions corporation and the electing corporation within the meaning of section 936. Under section 1504(b), a section 936 possessions corporation is required to file a separate U.S. corporate return and is therefore ineligible to join in the parent corporation's consolidated return. The issues before us for partial summary judgment arise out of the section 936 tax credit, which is designed to encourage investment and employment in Puerto Rico and other possessions of the United States. The amount of the credit is derived from the amount of the "combined taxable income" (sometimes referred to as CTI) derived from the "possession product". The primary dispute in the instant case involves the dividing of income and expenses between related parties. More specifically, the dispute involves whether the use of a formulaic calculation, or rather a calculation based upon factual relationships, is mandated in order to obtain the proper allocation and apportionment of expenses to the gross income

derived from the sale of a component possession product by a U.S. affiliate.

Petitioner filed its Federal income tax returns for taxable years 1983 through 1986 relying in part on section 1.936– 6(b)(1), Q&A-12, Income Tax Regs. (Q&A-12). The Commissioner issued a deficiency notice to petitioner in 1991 for taxable years 1983 and 1984. Petitioner filed a motion for partial summary judgment in that prior case, docket No. 17171– 91, similar to the one filed in the instant case. The Commissioner thereafter conceded the prior case in November 1992. On November 10, 1992, the Commissioner opened a regulation project with respect to the computation of combined taxable income under section 936(h). In October 1993, respondent issued the notice of deficiency in the instant case, determining deficiencies in petitioner's Federal income taxes for 1985 and 1986 in the amounts of $30,504,383 and $42,640,008, respectively. Respondent determined that petitioner was not entitled to the amount of the section 936 tax credit claimed on its returns for the years at issue. The petition in the instant case was filed January 4, 1994. On January 12, 1994, respondent's proposed amendment to Q&A-12 was published in the Federal Register. See infra note 5.

A secondary dispute in the instant case involves the treatment of interest expense with respect to computing combined taxable income under section 936. We are asked to decide whether petitioner may net interest income against interest expense in determining the amount of interest deduction to be allocated and apportioned in computing combined taxable income. Respondent contends that interest netting violates section 1.861-8(e)(2), Income Tax Regs., and petitioner must allocate and apportion the amount of its gross interest expense in determining combined taxable income. As a preliminary matter, we summarily reject respondent's argument and find, without further analysis, on the basis of Bowater Inc. v. Commissioner, 101 T.C. 207 (1993), that petitioner may net interest income against interest expense in determining the amount of interest deduction to be allocated and apportioned in computing combined taxable income under section 936 and section 1.861-8(e)(2), Income Tax Regs. See also General Portland Cement Co. v. United States, 628 F.2d 321 (5th Cir. 1980).