Rev. Rul. 82-211

ISSUE

What is the basis for computing the manufacturers excise tax imposed on firearms by section 4181 of the Internal Revenue Code when firearms are sold under the circumstances described below?

FACTS

X corporation is an importer of taxable firearms, all of which it sells to Y corporation. C, D (sibling of C), E and F (children of C) hold 50.3 percent of Xs shares. Z, an unrelated corporation, holds 49.7 percent.

C and D and their parents, A and B, hold 100 percent of Y's shares.

X and Y share the same premises, have the same officers and operate with a common pool of employees. However, X's and Y's fixed assets are separated for the most part. They maintain separate inventories, expenses incurred by them are kept separate to the extent possible, and any shared expenses are allocated between them. In addition to the firearms which Y purchases from X, Y also purchases goods from companies other than X. Y sells all of its goods, whether or not purchased from X, under its own name and at prices which it sets. Thus both corporations have substance and the transactions between them are viewed as actual sales.

Y offers the firearms for sale to retailers and to wholesale distributors and makes occasional sales at retail. Actual sales to wholesale distributors, however, make up a very small percentage of Y's sales. Because of the relatively small volume of sales to wholesale distributors, some articles, even though offered to wholesale distributors, have been sold only to retail dealers. The articles that Y actually sells only to retail dealers will be referred to as article 1 and the articles that Y sells to wholesale distributors will be referred to as article 2.

X's selling price of article 1 to Y is less than 90 percent of Y's lowest price to independent retailers and X's selling price of article 2 to Y is less than 95 percent of Y's price to wholesale distributors.

LAW AND ANALYSIS

Section 4181 of the Code imposes an excise tax on the sale of various firearms by the manufacturer, producer, or importer.

Section 4216(b)(1)(C) of the Code states that if a taxable article is sold otherwise than through an arm's length transaction and at less than fair market price, a constructive sale price must be used to compute the tax imposed under Chapter 32 of the Code. The constructive sale price is based upon the Secretary's determination of the price at which such articles are sold by manufacturers or producers in the ordinary course of trade.

Under section 48.4216(b)-2(e) of the Manufacturers and Retailers Excise Tax Regulations, a sale is considered to be made under circumstances other than at "arm's length" if: (1) one of the parties is controlled (in law or in fact) by the other, or there is common control, or (2) the sale is made under special arrangements between a manufacturer and a purchaser.

In Creme Manufacturing Co. v. United States, 492 F.2d 515 (5th Cir. 1974), two companies with no common ownership were held to be making sales in other than arm's length transactions. One corporation was owned by a man and wife and the other by their sons. The two corporations shared common facilities and some-of the same employees. In addition there had been no change in the operations of the two corporations from the time when the parents owned both corporations. Even though the owners were legally free to break the corporate ties, there was no evidence they contemplated doing so and the court was convinced that each corporation was operating with an eye toward the success of the other. The court stated that "viewing the totality of the relationship ... the corporations did not exhibit adverse economic interests."

Similarly, there are familial ties among stockholders of the two corporations since the stockholders of Y and their relatives own 50.3 percent of the stock of X. This fact, together with the existence of close operating ties and common corporate officers, indicates that X and Y have common economic interests and are subject to common control in fact. The sales between X and Y are therefore not at arm's length for purposes of section 4216(b)(1)(C) of the Code.

Sections 4216(b)(3), (4), and (5) of the Code provide for constructive sale prices when certain articles are sold by the manufacturer to a related distributor who, in turn, sells to independent retailers. However, under those sections the related parties must be members of an affiliated group as defined in section 1504(a). Rev. Rul. 62-68, 1962-1 C.B. 216, modified by Rev. Rul. 70-553, 1970-2 C.B. 266, and amplified by Rev. Rul. 71-240, 1971-1 C.B. 372, utilizing by way of example a fact situation involving sales by a parent company to a wholly-owned subsidiary which in turn, sells to one or more independent wholesale distributors, establishes rules for determining constructive sales prices.

When sales are not at arms length, the Commissioner, as the Secretary's delegate, determines a constructive sale price under the general provisions of section 4216(b)(1)(C) of the Code and a fair market price according to the price at which such articles are sold in the ordinary course of trade.

Rev. Rul. 78-10, 1978-1 C.B. 356, holds that the constructive sale price percentages prescribed in sections 4216(b)(3) and (b)(5) of the Code are to be applied to sales conducted in the same manner as set forth in sections 4216(b)(3) and (b)(5), even though the parties to the sale are not members of an affiliated group, as defined in section 1504(a), as required for application of section 4216(b)(3) and (b)(5).

The rules and election set forth in Rev. Rul. 62-68, as modified and amplified, however, apply to any situation not explicitly addressed by section 4216(b)(3), (b)(4), and (b)(5) of the Code. See S. Rep. 91- 1444, 91st Cong., 2d Sess., 1971-1 C.B. 574, 585.

Under Rev. Rul. 62-68, a company that sells taxable articles to a wholly-owned subsidiary may elect to use as a basis for tax, a constructive sale price equal to 95 percent of the subsidiary's lowest established wholesale price. If no election is made, the constructive sale price must be equal to the actual price at which the article leaves the corporate fan-&y in the ordinary course of trade. See Rev. Rul. 70- 553 for limitations and restrictions on the use of constructive sale prices established under Rev. Rul. 62-68.

Under Rev. Rul. 71-240, 1971-1 C.B. 372, and Rev. Rul. 77-66, 1977- 1 C.B. 338, the applicable constructive sale price rules must also be used to indicate the appropriate fair market price on an intercompany sale.

With regard to article 1, the taxpayer, X, may elect to compute its constructive sale price based upon 90 percent of the lowest price for which Y regularly sells that article in arm's length transactions to independent retailers. In lieu of such election, the constructive sale price should be the actual price (less statutory reductions) at which that article is sold by Y to an unrelated party. Thus, under Rev. Rul. 77-66, the fair market price to Y for article 1 is 90 percent of the lowest price for which Y regularly sells the article in arm's length transactions to independent retailers. Since X's actual price to Y for article 1 is less than this amount, it is less than fair market price.

The taxpayer may elect to use the same constructive sale price percentage prescribed in Rev. Rul. 62-68 when the sales practices of the corporations are the same as those set forth in Rev. Rul. 62-68. Therefore, under Rev. Rul. 71-240, the fair market price for such sales is 95 percent of Y's lowest established resale price to unrelated wholesale distributors. Since X's actual price to Y for article 2 is less than this, it is less than fair market price.

HOLDING

The taxpayer may elect to have the manufacturers excise tax on X's sales of article 1 to Y computed upon a constructive sale price of 90 percent of the lowest price for which Y regularly sells such articles in arm's length transactions to independent retailers. This computation is made without adjustment for any exclusion (except for the tax imposed on such article) or readjustment under subsections (a) and (e) and under section 6416(b)(1) of the Code. If the taxpayer does not exercise this election, the constructive sale price will be based upon the actual price (less statutory reductions) at which article 1 is sold by Y to an unrelated party.

The manufacturers excise tax upon X's sales of article 2 to Y will be computed upon a constructive sale price to be determined under Rev. Rul. 62-68. If X does not make the election provided for by Rev. Rul. 62-68, then, under Rev. Rul. 70-553, tax will be computed under the rules provided in section 4216(b)(2) of the Code, since Ys sales of article 2 are within the terms of that provision.

In selecting the method by which a manufacturer computes and pays tax due under Chapter 32 of the Code, pursuant to this ruling, he must follow the procedure outlined below:

(1) Where a manufacturer desires to exercise an-election to compute and pay tax based on 90 or 95 percent of the selling company's lowest established wholesale price, the manufacturer shall notify the District Director of such election by attaching a statement to the return, Form 720, filed for the quarter in which the election is made. If the election is not made, no notice need be served upon the District Director.

(2) Where a manufacturer using the election method no longer wishes to use this optional basis for tax, he must notify the District Director of his intent to use the alternative tax base prescribed in this ruling by attaching a statement to this effect to the return filed for the quarter preceding the quarter in which the change is to be made.

EFFECT ON OTHER REVENUE RULINGS

. Rev. Rul. 78-10, 1978-1 C.B. 356, is modified to allow taxpayers to elect to use a constructive sale price based upon the same percentages expressed in sections [sic] 4216(b)(3) or (b)(5) of the Code. In the absence of such an election, the constructive sale price will be the actual price (less statutory reductions) at which the taxable article is sold to an unrelated party.