Rev. Rul. 70-553

Advice has been requested as to the determination of a constructive sale price under the circumstances described below.

A corporation that manufactures automobile truck parts taxable under section 4061(b)(1) of the Internal Revenue Code of 1954 established a wholly-owned selling subsidiary to distribute the truck parts. All of the parts manufactured by the corporation are sold to its selling company. The selling company, besides selling its products to wholesale distributors and ultimate consumers, also includes retail dealers among its customers.

The selling company has such substance and reality as to evidence that it operates separately from the manufacturer. Accordingly, the manufacturer's sales of truck parts to the selling company are recognized as sales, for manufacturers excise tax purposes. However, because of the relationship between the selling company and the manufacturer, the sales between them are not at arm's length. Furthermore, it has been determined that the manufacturer's sale price to the selling company is less than the fair market price of the truck parts. Therefore, the provisions of section 4216(b)(1)(C) of the Code are applicable. The manufacturer does not elect to use as a basis for tax on sales to its selling company a constructive sales price based on the 95 percent formula provided by Revenue Ruling 62-68, C.B. 1962-1, 216.

Section 4216(b)(1)(C) of the Code relates to the determination of a constructive sale price in cases where an article subject to the manufacturers excise tax on the basis of sale price is sold (otherwise than through an arm's length transaction) at less than the fair market price of the article. In such cases the manufacturers excise tax is to be computed on the price for which the article is sold, in the ordinary course of trade, by manufacturers or producers thereof, as determined by the Secretary of the Treasury or his delegate.

Revenue Ruling 62-68 provides that in the case of intercompany sales at less than fair market value, the manufacturer of the taxable articles may elect to use as a basis for tax on such sales, a constructive sale price equal to 95 percent of the related selling company's lowest established resale price for the taxable articles to unrelated wholesale distributors in the ordinary course of trade. This 5 percent margin is an allowance, for those exclusions from, and readjustments of, the selling company's resale price that sections 4216 and 6416 of the Code would allow a manufacturer selling in the ordinary course of trade to unrelated distributors.

In the event the manufacturer does not exercise the election described above, Revenue Ruling 62-68 also provides that the constructive sales price would be the actual selling price at which the taxable article leaves the corporate family in the ordinary course of trade, that is the actual wholesale price at which the selling company sells to unrelated customers, except that if the sale by the selling company is at retail, and if it has an established bona fide practice of selling such articles in substantial quantities to wholesale distributors, the basis for tax shall be the lower of (1) the actual price for which the article is sold, or (2) the highest price for which such articles are sold by the selling company to wholesale distributors.

Since the manufacturer in the instant case does not wish to elect the 95 percent formula provided by Revenue Ruling 62-68, it would appear, that under a literal application of the provisions of Revenue Ruling 62-68, the constructive sale price for the manufacturing corporation's sales would be (1) the actual price of the selling company, not only in the case of sales by the selling company to wholesale distributors but also in the case of sales by the selling company to retail dealers, and (2) the selling company's highest wholesale distributor price (where lower than the actual price for which the article is sold) in the case of sales by the selling company at retail.

However, if the manufacturer sold directly to the selling company's customers (rather than through the selling company) it would meet all the necessary conditions set forth in section 4216(b)(2) of the Code, and would be entitled to a constructive sale price on such sales determined under the special rule provided by that section. With respect to sales to retail dealers, the constructive sale price provided by section 4216(b)(2) is the lower of (1) the price for which the article is sold, or (2) the highest price for which the article is sold by the manufacturer to wholesale distributors.

In view of the fact that a manufacturer selling directly to unrelated customers, under otherwise similar circumstances to those of the manufacturer in this case, would be entitled to use the special rule of section 4216(b)(2) of the Code, the question is whether the manufacturer in this case should be required to use a constructive sale price higher than that which would be determined under the special rule. More specifically, in determining a constructive sale price in cases where a selling company sells to retail dealers, the question is whether the manufacturing company's constructive sale price should be no higher than the selling company's highest price to wholesale distributors where that price would be lower than the actual price at which the product is sold by the selling company to retail dealers.

It is held that if a manufacturer makes intercompany sales otherwise than at arm's length and at less than fair market price and no election is made under Revenue Ruling 62-68, his constructive sale price determined under section 4216(b)(1) of the Code, will be no higher than the constructive sale price determined under section 4216(b)(2), provided, however, that the selling company resells under conditions that would entitle it to a constructive sale price determined under section 4216(b)(2), if the selling company were a manufacturer.

Accordingly, in the instant case, the constructive sale price for taxable automobile truck parts resold by the selling company to retail dealers is the lower of (1) the selling company's actual sale price, or (2) the highest established price for which the selling company sells such parts to wholesale distributors.

Revenue Ruling 62-68 is hereby modified to the extent it would provide that under the facts presented in the instant case, the constructive sales price for taxable automobile truck parts resold by the selling company to retail dealers is the actual price of the selling company to retail dealers.

It should be noted that in the case of automobile articles subject to the tax imposed by section 4061(a) of the Code (automotive chassis and bodies) the special rule provided by section 4216(b)(2) applies only where it is not the normal method within the industry to sell such articles at retail or to retailers, or combinations thereof.