Volvo Cars of North America, LLC v. United States

Filed: July 13, 2009

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

No. 08-1080
(2:95-cv-00571-WO)

VOLVO CARS OF NORTH AMERICA, LLC; VOLVO GROUP NORTH
AMERICA, INCORPORATED,

Plaintiffs - Appellants,

v.

UNITED STATES OF AMERICA,

Defendant – Appellee.

O R D E R

The court amends its opinion filed July 9, 2009, as

follows:

On the cover sheet, district court information section --

the name of “William L. Osteen, Jr., District Judge” is deleted

and is replaced by “William L. Osteen, Sr., Senior District

Judge.”

For the Court – By Direction

/s/ Patricia S. Connor
Clerk
 PUBLISHED

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

VOLVO CARS OF NORTH AMERICA, 
LLC; VOLVO GROUP NORTH
AMERICA, INCORPORATED,
Plaintiffs-Appellants,
 No. 08-1080
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.

Appeal from the United States District Court
for the Middle District of North Carolina, at Greensboro.
William L. Osteen, Sr., Senior District Judge.
(2:95-cv-00571-WO)

Argued: March 26, 2009

Decided: July 9, 2009

Before NIEMEYER and MICHAEL, Circuit Judges, and
Eugene E. SILER, Jr., Senior Circuit Judge of the United
States Court of Appeals for the Sixth Circuit,
sitting by designation.

Vacated and remanded with instructions by published opin-
ion. Judge Niemeyer wrote the opinion, in which Judge
Michael and Senior Judge Siler joined.
2 VOLVO CARS v. UNITED STATES
COUNSEL

ARGUED: Charles Alan Rothfeld, MAYER BROWN, LLP,
Washington, D.C., for Appellants. Bridget Maria Rowan,
UNITED STATES DEPARTMENT OF JUSTICE, Washing-
ton, D.C., for Appellee. ON BRIEF: Charles P. Hurley,
Nicole Reuling, Golaleh Kazemi, MAYER BROWN, LLP,
Washington, D.C., for Appellants. Nathan J. Hochman, Assis-
tant Attorney General, Jonathan S. Cohen, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C.; Anna
Mills Wagoner, United States Attorney, Greensboro, North
Carolina, for Appellee.

OPINION

NIEMEYER, Circuit Judge:

In this federal income tax refund case, Volvo Cars of North
America, Inc., and its subsidiaries and predecessors (collec-
tively "Volvo"), wrote off excess and slow-moving inventory
that it purportedly sold to a warehouser under an April 6,
1983 contract, thus reducing its taxable income for the 1983
tax year. When the IRS asserted that the sales were not bona
fide sales, because Volvo retained control over the inventory
even after Volvo transferred the inventory, Volvo paid the
taxes avoided by the write-off and commenced this action
against the United States for a refund.

The jury returned a verdict in Volvo’s favor, finding that
the purported sales to the warehouser — both before and after
execution of the April 6, 1983 contract — were indeed bona
fide sales, thereby entitling Volvo to a tax refund in the 1983
tax year in the amount of $2.8 million, plus interest. The dis-
trict court, however, entered a judgment notwithstanding the
verdict in favor of the government with respect to transfers of
inventory made prior to execution of the contract, concluding
 VOLVO CARS v. UNITED STATES 3
as a matter of law that the April 6, 1983 contract did not
address inventory previously transferred to the warehouser.

Because we conclude that Volvo presented sufficient evi-
dence from which the jury could reasonably have concluded
that the April 6, 1983 contract effected a bona fide sale of the
previously transferred inventory, we vacate the judgment and
remand to the district court for entry of judgment consistent
with the jury’s verdict.

I

Volvo, a manufacturer of motor vehicles, including trucks,
sought to reduce its inventory of slow-moving and excess
replacement parts for trucks through an arrangement with a
warehouser by which it physically transferred the parts to the
warehouser but maintained sufficient control over them to
purchase them back when needed by customers, and at the
same time it sought to create the conditions for a tax write-off
that was available for sales of inventory.1

To accomplish its purposes, Volvo initially entered into an
April 18, 1980 contract (the "1980 Contract") with Sajac
Company, Inc., a warehouser which described itself as an "in-
ventory management specialist" that was "in the business of
purchasing and holding for resale the excess parts inventories
1
For a manufacturing business, "gross income" for tax purposes means
the total sales, less cost of goods sold. 26 C.F.R. § 1.61-3. The cost of
goods sold is determined by subtracting the year-end inventory from the
total inventory available during the year, so that the taxpayer excludes
goods that have been sold from ending inventory. 26 C.F.R. § 1.471-1.
Reducing the year-end inventory thus increases the cost of goods sold and
correspondingly reduces income. Thus, a manufacturer that expends
money to manufacture or purchase spare parts may not deduct the expense
as long as the parts remain unsold in inventory. Even selling spare parts
for scrap prices is more attractive to a manufacturer from a tax perspective
than continuing to hold parts in inventory unsold. See Thor Power Tool
Co. v. Commissioner, 439 U.S. 522, 545-46 (1979).
4 VOLVO CARS v. UNITED STATES
of various manufacturers." Manufacturers would transfer their
excess parts to Sajac for scrap prices, and Sajac would then
store the parts for as long as 10 to 15 years in its own high-
density, computerized warehouses. If the manufacturer had a
need for a part later, the manufacturer would be able to repur-
chase it from Sajac at a price well above scrap price but well
below the cost of manufacturing or buying the part. Volvo
and Sajac believed that this arrangement would allow Volvo
to claim a tax write-off for the inventory so transferred to
Sajac, while also providing the parties with mutual economic
benefits.

The terms of the 1980 Contract with Sajac passed "[a]ll
right, title and interest" in the excess inventory to Sajac, but
they also provided for Volvo to retain a number of important
aspects of control over the inventory, including the right to
repurchase it at 90% of standard cost. In the 1980 Contract,
Sajac also promised to notify Volvo prior to any planned dis-
position of Volvo parts inventory to third parties, giving
Volvo an opportunity to repurchase that inventory before
Sajac sold it to others. Finally, the 1980 Contract allowed
either party to cancel the arrangement unilaterally, upon 60
days written notice.

Because of the control that manufacturers such as Volvo
retained over inventory transferred under contracts with Sajac,
such as the 1980 Contract, the IRS began to challenge the
manufacturers’ write-offs, asserting that the transfers of
inventory to Sajac were not "bona fide arms-length sales for
federal income tax purposes." Rev. Rul. 83-59, 1983-1 C.B.
103. Rather, the IRS asserted that such an arrangement was
"in substance . . . merely . . . a warehousing and inventory
management service arrangement." Id. The Tax Court sus-
tained the IRS’ position in Paccar, Inc. v. Commissioner, 85
T.C. 754 (1985), aff’d, 849 F.2d 393 (9th Cir. 1988), and the
parties here agree that Paccar now provides the standard for
 VOLVO CARS v. UNITED STATES 5
determining whether transfers of inventory are bona fide sales
for federal income tax purposes.2

In response to the threat of an IRS challenge to the write-
offs, Volvo and Sajac entered into a new contract on April 6,
1983 (the "1983 Contract"). But unlike the 1980 Contract, the
1983 Contract eliminated the provisions that the IRS had
identified as indicating that the sales were not bona fide sales.
At its core, it specified, "the Sajac Company, Inc. (‘Sajac’)
agrees to purchase and the undersigned Seller [i.e., Volvo]
agrees to sell, certain of Sellers’ inventory." This contract did
not give Volvo the same rights of control over the inventory
that the 1980 Contract did. In particular, it did not require
Sajac to notify Volvo before Sajac sold the inventory to third
persons.

The IRS nonetheless challenged all of Volvo’s inventory
transfers to Sajac between 1981 and 1990 — whether under
the 1980 Contract or the 1983 Contract — on the basis that
they were not bona fide sales. Volvo conceded, in light of
Paccar, that the transfers under the 1980 Contract were not
bona fide sales inasmuch as the 1980 Contract was very simi-
lar to the contract in Paccar. See 85 T.C. at 756-57. Accord-
ingly, Volvo settled the IRS’ claims for tax years 1981 and
1982, for which only the 1980 Contract governed the Volvo-
Sajac relationship. But Volvo maintained that all sales under
the 1983 Contract were bona fide sales, and further that the
1983 Contract replaced the 1980 Contract, thus effecting a
bona fide sale on April 6, 1983, of the inventory that had been
previously transferred to Sajac.
2
In Paccar, the Tax Court set out four factors to consider in determining
whether transfers of inventory to Sajac are bona fide sales: "(1) Who
determined what items were taken into inventory; (2) who determined
when to scrap existing inventory; (3) who determined when to sell inven-
tory; and (4) who decided whether to alter inventory." 85 T.C. at 779. See
also Rexnord, Inc. v. United States, 940 F.2d 1094 (7th Cir. 1991); Robert
Bosch Corp. v. Commissioner, 58 T.C.M. (CCH) 921 (1989); Clark Equip.
Co. v. Commissioner, 55 T.C.M (CCH) 389 (1988).
6 VOLVO CARS v. UNITED STATES
After the IRS disallowed all of Volvo’s write-offs for trans-
fers to Sajac, Volvo paid the taxes that would have been due
if the IRS’s position were correct and commenced this action
for a refund. Volvo’s complaint claimed refunds for tax years
1983, 1985, 1986, 1987, and 1989, resulting from the IRS’
allegedly improper rejection of the write-offs. Specifically,
for the tax year 1983, which is the only tax year at issue in
this appeal, Volvo alleged that the IRS’ position improperly
increased its income in the amount of $6,101,960, for which
it was entitled to a tax refund of $2,807,902, plus interest.

The case was tried to a jury, which heard testimony from
Volvo employees and former Sajac employees about the
course of the Volvo-Sajac relationship. The evidence was
offered to show that once Volvo transferred the parts, both its
conduct and Sajac’s conduct were consistent with completed
bona fide sales under the Paccar factors. See 85 T.C. at 779.
These witnesses testified that when Sajac went out of business
in 1991, it sold all of its Volvo parts inventory to Lippert
Enterprises, an unrelated third party, without providing any
notice of the sale to Volvo until after the sale had been com-
pleted; that even before its 1991 liquidation, Sajac sold Volvo
inventory to third parties "on a daily basis" without "ever go[-
ing] and ask[ing] anybody at Volvo for permission or
approval"; and that Sajac would often scrap or alter inventory
without Volvo’s permission or knowledge.

To aid in resolving the parties’ various contentions about
the function of the 1983 Contract, the district court submitted
two questions to the jury. The first question required the jury
to determine whether the inventory physically transferred
before the 1983 Contract’s execution on April 6, 1983, was
the subject of a bona fide sale in 1983, as Volvo alleged in its
complaint. The second question required the jury to determine
whether the inventory transfers after April 6, 1983, were bona
fide sales. The court also instructed the jury on the four rele-
vant factors set forth in Paccar, 85 T.C. at 779.
 VOLVO CARS v. UNITED STATES 7
The jury returned a verdict in favor of Volvo, finding that
the transfers both before and after the execution date of the
1983 Contract were the subject of bona fide sales for federal
tax purposes. The government then filed a renewed motion for
judgment as a matter of law under Federal Rule of Civil Pro-
cedure 50(b), contending that Volvo had presented insuffi-
cient evidence for a reasonable jury to find that any of the
transfers were bona fide sales. The district court denied the
motion regarding the inventory transferred after April 6,
1983, stating:

Viewing the conflicting evidence in a light most
favorable to Volvo, the court finds that there is a
legally sufficient basis upon which a reasonable jury
could conclude that Sajac exercised control of its
Volvo inventory, and, moreover, did not hold the
inventory pending repurchase by Volvo. As
instructed by the court, the jury applied the [Paccar]
multiple factor test to the conflicting evidence before
it and determined that Volvo’s transfers of inventory
to Sajac were bona fide sales of inventory for tax
purposes.

But regarding the inventory transferred before April 6, 1983,
the court granted the government’s motion, concluding, as a
matter of law, that this inventory was not addressed by the
1983 Contract and was covered only by the 1980 Contract,
which Volvo concedes did not effect bona fide sales.

From the district court’s judgment in favor of the govern-
ment regarding inventory transferred before April 6, 1983,
Volvo filed this appeal.

II

Volvo’s principal reason for entering into the 1980 Con-
tract with Sajac was to obtain a write-off for the sale of slow-
moving and excess inventory, although it also sought to
8 VOLVO CARS v. UNITED STATES
reduce inventory and the costs associated with storing and
managing it. The parties agree, however, that in order to
obtain a tax write-off for the sale of inventory, the sale must
be a completed bona fide sale that relinquishes control over
the inventory. See Paccar, 85 T.C. at 781. The parties also
agree that the 1980 Contract did not satisfy the criteria for a
completed bona fide sale, as articulated in Paccar, 85 T.C. at
779, because Volvo retained too much control over the inven-
tory even after it physically transferred the inventory to Sajac.

In response to the threat of an IRS challenge to the inven-
tory write-offs, Volvo and Sajac entered into the 1983 Con-
tract, which eliminated the fatal terms that gave Volvo control
over inventory in the 1980 Contract, and the parties agree that
transfers of inventory under the 1983 Contract satisfied the
Paccar standards, as the jury found. The district court con-
cluded that sufficient evidence supported the jury’s finding in
that regard, and the government has not appealed that finding.

The sole issue on appeal is whether the 1983 Contract
effected a sale of the inventory that had been previously trans-
ferred to Sajac under the 1980 Contract. Posited otherwise, if
the inventory transferred to Sajac under the 1980 Contract
was not the subject of bona fide sales to Sajac but rather were
made under what amounted to a warehousing arrangement, as
the government contended, did the 1983 Contract effect a sale
of that previously transferred inventory? The resolution of this
question turns on whether the 1983 Contract addressed the
earlier transferred inventory such that the 1983 Contract
replaced the 1980 Contract or whether the 1983 Contract was
a new, separate contract operating in parallel with the 1980
Contract, each covering different inventory. The parties
acknowledge that if the 1983 Contract replaced the 1980 Con-
tract, Volvo is entitled to the tax write-off from the sale of
inventory previously transferred to Sajac.

In determining whether the language of the 1983 Contract
covers inventory previously transferred to Sajac, we look to
 VOLVO CARS v. UNITED STATES 9
state law because "in the application of a federal revenue act,
state law controls in determining the nature of the legal inter-
est which the taxpayer had in the property." United States v.
Nat’l Bank of Commerce, 472 U.S. 713, 722 (1985) (quoting
Aquilino v. United States, 363 U.S. 509, 513 (1960)) (internal
quotation marks and alteration omitted). But "[o]nce it has
been determined that state law creates sufficient interests in
the taxpayer to satisfy the requirements of [the Tax Code],
state law is inoperative, and the tax consequences thenceforth
are dictated by federal law." Id. (quoting United States v.
Bess, 357 U.S. 51, 56-57 (1958)) (internal quotation marks
and alteration omitted). In the present appeal, the parties do
not dispute that the 1983 Contract resulted in a bona fide sale
for purposes of federal tax law. Rather, this case turns on the
question of state law, whether the 1983 Contract addressed
the previously transferred inventory.

Volvo contends that the commercial context, as well as the
parties’ mutually accepted course of performance, points to
the conclusion that the 1983 Contract replaced the 1980 Con-
tract and thus covered not only inventory to be transferred
after execution of the 1983 Contract but also inventory that
had been transferred to Sajac under the 1980 Contract and
was still in Sajac’s warehouses or had been purchased from
Sajac by third parties.

The government, relying on particular language in the 1983
Contract, argues that the 1983 Contract was forward-looking
and did not cover inventory previously transferred to Sajac. It
also argues that because no party invoked the cancellation
clause in the 1980 Contract, that contract remained in place
even as the 1983 Contract was executed. Thus, according to
the government, the 1983 Contract was a new and separate
contract operating in parallel with the 1980 Contract, each
covering different inventory.

We begin with the language of the 1983 Contract. The con-
trolling language is in its first sentence, which states, "Subject
10 VOLVO CARS v. UNITED STATES
to the terms and conditions below, The Sajac Company, Inc.
(‘Sajac’) agrees to purchase and [Volvo] agrees to sell, cer-
tain of [Volvo’s] inventory." (Emphasis added). This sentence
defines the full operation of the 1983 Contract, yet the con-
tract does not contain any other language defining what is
included in "certain inventory."

The government, nonetheless, argues that the earlier trans-
ferred inventory could not have been encompassed by the
"certain inventory" sold in the 1983 Contract because the
1983 Contract uses future tenses regarding the details of
transportation and payment arrangements. These uses of the
future tense, however, do not restrict the scope of or define
that "certain inventory" which was sold to Sajac in the first
sentence of the contract. These future-tense terms simply gov-
ern the details of transportation and payment for inventory
that had not yet been transferred but would be transferred
after the execution of the contract.

Wisconsin law, which, by the terms of the 1983 Contract,
governs, provides the appropriate means of defining "certain
inventory." The Wisconsin codification of the Uniform Com-
mercial Code states:

Terms . . . which are . . . set forth in a writing
intended by the parties as a final expression of their
agreement with respect to such terms as are included
therein . . . may be explained or supplemented:

(1) . . . by course of performance.

Wis. Stat. § 402.202 (emphasis added). The official comment
on this section explains the importance of § 402.202’s opera-
tion:

This section definitely rejects:

***
 VOLVO CARS v. UNITED STATES 11
(b) The premise that the language used has the
meaning attributable to such language by rules
of construction existing in the law rather than
the meaning which arises out of the commer-
cial context in which it was used; and

(c) The requirement that a condition precedent to
the admissibility of the type of evidence speci-
fied in paragraph (a) [i.e., course of perfor-
mance] is an original determination by the
court that the language used is ambiguous.

Id. cmt. 1 (emphasis added). Thus, we are not to rely solely
on canons of contract interpretation, such as verb tenses, in
interpreting the scope of the term "certain inventory," but we
must also consider the "course of performance" and "commer-
cial context" of the provision. Moreover, we need not deter-
mine whether the contract is ambiguous before considering
evidence of course of performance. See also Wis. Stat.
§ 402.208(1).

While we thus look to state law to determine the nature of
the interest that Volvo has in the previously transferred inven-
tory, see Nat’l Bank of Commerce, 472 U.S. at 722, we look
to federal law for the tax consequences of that interest. But
even in applying federal law to determine the tax conse-
quences of a transaction defined by state law, we look to "the
intention of the parties as evidenced by the written agree-
ments read in light of the attendant facts and circumstances."
Paccar, 85 T.C. at 777 (emphasis added). Similarly, we have
long held that the parties’ intent and the relevant facts are cru-
cial in construing contracts for federal tax purposes. See Gen.
Ins. Agency, Inc. v. Commissioner, 401 F.2d 324, 329-30 (4th
Cir. 1968).

Thus, in the present case, evidence of "course of perfor-
mance" and "commercial context" may be considered in
12 VOLVO CARS v. UNITED STATES
determining what "certain inventory" in the 1983 Contract
means. That evidence shows the following.

First, the reason for entering into the 1983 Contract was to
reformulate the 1980 Contract so as to eliminate the provi-
sions identified by the IRS as precluding tax write-offs for
inventory sales to Sajac. As the district court noted, in the
1983 Contract, "Sajac modified its standard contract with
manufacturers as the result of several Tax Court decisions
finding that no bona fide sales had occurred under terms virtu-
ally identical to those of the [1980 Contract]." Moreover, a
Volvo employee testified at trial that in response to "a tax
case," i.e., Paccar, involving Sajac and "one of their other
customers, . . . the management of our company [Volvo] and
Sajac sat down and looked at things, . . . and we rewrote [the]
contract at that point."

Second, both the 1980 Contract and the 1983 Contract
addressed the same subject matter, sales of slow-moving and
excess inventory to Sajac for the mutual benefit of the parties
and for a tax write-off for Volvo. There was no evidence that
the parties intended to divide the inventory for different treat-
ments, and there was no purpose for the 1983 Contract other
than to strengthen the argument for the tax write-offs.

Third, the method by which Sajac maintained all Volvo
excess parts inventory remained the same. There was no evi-
dence showing that after execution of the 1983 Contract,
Sajac distinguished in any respect its treatment of inventory
transferred under the 1980 Contract or that it was even aware
of a need or desire to make a distinction. Indeed, the evidence
was uncontroverted that Sajac did not change its conduct with
respect to Volvo inventory after execution of the 1983 Con-
tract. Sajac did nothing to segregate or differentiate the previ-
ously transferred inventory from the inventory transferred
after execution of the 1983 Contract. Had the parties believed
that they were operating under two separate contracts, Sajac
would certainly have distinguished the inventories because
 VOLVO CARS v. UNITED STATES 13
Volvo had significantly more rights and control in inventory
transferred under the 1980 Contract than in inventory trans-
ferred under the 1983 Contract. Moreover, maintaining two
categories of Volvo inventory for replacement parts would
have been a legal and logistical nightmare, with Sajac segre-
gating the inventory in its warehouses to comply with two
separate legal regimes. Volvo presented extensive evidence
tending to show that the segregation requisite to the govern-
ment’s position never took place.

Fourth, when Sajac went out of business in 1991, it sold all
of its Volvo inventory—both pre-1983 Contract and post-
1983 Contract inventory—to Lippert Enterprises without pro-
viding any notice whatsoever to Volvo. Several witnesses tes-
tified that Volvo learned of the sale only well after it was
completed. Yet, the 1980 Contract expressly required Sajac to
give advance notice to Volvo of any planned disposition,
while the 1983 Contract lacked any such provision. If, as the
government contends, the 1980 Contract remained in force for
inventory transferred prior to the 1983 Contract’s execution,
then Sajac would have been required to give advance notice.
But it did not, giving rise to a strong inference that the 1983
Contract governed all Volvo inventory.

This evidence relating to course of performance and com-
mercial context could well have been taken by the jury to
define the term "certain inventory" in the 1983 Contract, and
thus this evidence provides support for the jury’s rejection of
the government’s proposed interpretation of "certain inven-
tory."

The government relies heavily on the fact that neither party
cancelled the 1980 Contract pursuant to its cancellation
clause. Because of that, it maintains, the 1980 Contract must
have continued to govern the inventory that had been trans-
ferred to Sajac before execution of the 1983 Contract. The
1980 Contract provided that "This AGREEMENT shall con-
tinue in force and effect unless and until cancelled by either
14 VOLVO CARS v. UNITED STATES
party. Either party may cancel this AGREEMENT upon 60
days written notification of its intent to cancel." This cancella-
tion provision, however, does not provide the only way the
1980 Contract could end. Indeed, the clause only addresses
unilateral cancellation by a party—how one party may end
the contractual relationship. Surely, if both parties wished to
end the relationship, they could do so by mutual consent, as
the evidence in this case suggests they did.

The determination of whether the 1983 Contract replaced
the 1980 Contract or operated in parallel with it is a question
that involves both legal determinations and factual findings.
The jury was properly instructed on the Paccar factors and
was given the latitude to decide factually whether the 1983
Contract effected a completed bona fide sale of all inventory,
including inventory that had been previously transferred to
Sajac. Based on the evidence presented, we cannot conclude
that the jury acted unreasonably in concluding that the 1983
Contract did effect a bona fide sale of the previously trans-
ferred inventory. Because judgment as a matter of law is
proper only when "there can be but one reasonable conclusion
as to the proper judgment," United States ex rel. DRC, Inc. v.
Custer Battles, LLC, 562 F.3d 295, 305 (4th Cir. 2009) (quot-
ing Chaudhry v. Gallerizzo, 174 F.3d 394, 405 (4th Cir.
1999)), the district court erred in setting aside the jury’s ver-
dict and entering judgment as a matter of law.

Accordingly, we vacate the judgment of the district court
and remand with instructions to enter judgment consistent
with the jury’s verdict.

VACATED AND REMANDED WITH INSTRUCTIONS