Computervision Int'l Corp. v. Commissioner

T.C. Memo. 1996-131

UNITED STATES TAX COURT

COMPUTERVISION INTERNATIONAL CORP., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

COMPUTERVISION CORPORATION AND SUBSIDIARIES, Petitioners1 v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 25134-93, 25135-93. Filed March 18, 1996.

John S. Brown, George P. Mair, Donald-Bruce Abrams, Jody E.

Forchheimer, for petitioners.

Charles W. Maurer, Jr. and John C. Galluzzo, Jr., for

respondent.

1

These cases have been consolidated for purposes of trial,
briefing, and opinion and shall hereinafter be referred to as the
instant case.
 - 2 -

MEMORANDUM FINDINGS OF FACT AND OPINION

WELLS, Judge: Respondent determined a deficiency of

$9,460,419 in the Federal income tax of petitioner Computervision

International Corp. (CVI) for its taxable year ended January 31,

1984.

Respondent determined the following deficiencies in the

Federal income tax of petitioners Computervision Corp. (CV) and

subsidiaries for the following years:

Taxable Year Ended Deficiency

Dec. 31, 1983 $25,226
Dec. 31, 1984 32,279
Dec. 31, 1987 4,720,840
Feb. 5, 1988 570,819

After concessions, the following issues remain for decision:

(1) Whether CVI qualifies as a domestic international sales

corporation (DISC) for its taxable years ended January 31, 1983

and 1984;

(2) whether petitioners are entitled to net interest income

against interest expense in calculating CV's deduction for

commissions payable to CVI with respect to each of CVI's taxable

years ending January 31, 1983 and 1984, and December 31, 1984;

and,

(3) whether the net proceeds of the sale of a certain stock

warrant held by CV are long-term capital gain, ordinary income,

or a reduction in CV’s cost of goods sold.
 - 3 -

FINDINGS OF FACT

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 for the

years in issue. Some of the facts have been stipulated for trial

pursuant to Rule 91. The parties' stipulations are incorporated

in this Memorandum Opinion by reference and are found accordingly

except as noted below with respect to certain stipulations to

which objections were reserved.

General Background

The principal place of business of both CV and CVI was

Bedford, Massachusetts, at the time each filed its petition in

the instant case. CV, a Delaware corporation, designs,

manufactures, and sells computer-aided design, computer-aided

manufacturing, and computer-aided engineering (CAD/CAM/CAE)

products. CV maintains its books and records on an accrual

accounting basis using a calendar year.2 During relevant

periods, CVI, a Massachusetts corporation, maintained its books

and records on an accrual accounting basis using a fiscal year

ending January 31.3 During CV's and CVI's taxable years ending

2

In 1988, however, CV, together with at least certain of its
subsidiaries, filed a consolidated Federal income tax return for
the period beginning Jan. 1, 1988, and ending Feb. 5, 1988.
3

In 1985, however, CVI, filed a Form 1120-DISC for the period
(continued...)
 - 4 -

in 1983 and 1984, CVI was a wholly owned subsidiary of CV.

DISC Qualification Issue

CVI was organized in 1972 to serve as a sales agent for CV

with respect to CV's sales of its products to customers located

outside the United States. CVI qualified as a DISC for each of

its taxable years ending prior to the taxable years for which its

DISC status is in issue in the instant case (viz, its taxable

years ending January 31, 1983 and 1984 (relevant taxable years)).

Throughout the periods relevant to the instant case, Martin Allen

was CVI's president, Richard Krieger was its treasurer, and James

Spindler was its clerk. They were also the directors of CVI.

CV and CVI entered into a series of agreements with respect

to their export sales activities. Under a written agreement

entitled "Commission Agreement" (commission agreement) dated as

of March 22, 1972, that was in effect during the periods relevant

to the instant case, CVI was appointed CV's sales agent with

respect to CV's sales of CV's products to customers located

outside the United States. The commission agreement provided

that, in exchange for services provided under the agreement, CVI

would receive a commission equal to the maximum amount allowable

pursuant to section 994.

Pursuant to a written agreement entitled "Agreement

Designating Foreign Marketing Departments and Related

3
(...continued)
beginning Feb. 1, 1984, and ending Dec. 31, 1984.
 - 5 -

Intercompany Accounts" (export promotion agreement) dated as of

February 1, 1980, that was also in effect during the periods

relevant to the instant case, certain departments within CV were

designated foreign marketing departments of CVI for purposes of

accounting for export promotion expenses within the meaning of

section 994(c) to be incurred by CVI and certain accounts were

designated as export promotion expense accounts. Pursuant to the

export promotion agreement, CVI obligated itself to reimburse CV

annually for export promotion expenses accounted for in the

designated accounts that were to be paid by CV in the first

instance. The export promotion agreement provided that CV would

bill the expenses to CVI at the close of CVI's fiscal year and

that the amount due was payable within 60 days after billing.

Pursuant to a written agreement entitled "Accounts

Receivable Purchase Agreement" (master receivables purchase

agreement) dated as of January 31, 1981, CVI was authorized to

purchase from time to time an undivided interest in CV's accounts

receivable arising from certain of the types of transactions that

give rise to qualified export receipts pursuant to section

993(a)(1) and on which CVI was entitled to receive a commission

(qualified export receivables). Pursuant to the master

receivables purchase agreement, the purchase price to be paid for

the undivided interest in the qualified export receivables was to

be determined at the time of purchase and was to reflect a

reasonable discount on the amount of the receivables purchased.
 - 6 -

The agreement also provided that CV would produce, upon demand by

CVI, a list of the qualified export receivables in which CVI had

an interest, including the identity of the account debtor, the

amount of each receivable, and the date on which it arose. CV

was required to bill and collect all payments on the qualified

export receivables in which CVI had an interest on CVI's behalf

and, unless requested to remit the proceeds to CVI, to substitute

an undivided interest in additional receivables for those

discharged.

Using the commissions paid it by CV, CVI, pursuant to the

master receivables purchase agreement, periodically purchased at

a discount interests in CV's qualified export receivables that

were qualified export assets within the meaning of section

993(b). During its 1981 taxable year, CV entered into the

following sales of qualified export receivables to CVI at a

discount under the master receivables purchase agreement:

Date of Sale Receivables Face Amount

Oct. 1, 1981 $23,345,288
Oct. 15, 1981 1,874,000
Dec. 1, 1981 4,028,369

Under the terms of the sales, CV was obligated to pay to CVI all

proceeds collected with respect to CVI’s interest in the

qualified export receivables on September 30, 1982.

During 1982, CV made an election to use the installment

method to report its income with respect to domestic and foreign

sales. Because CV believed that further purchases of qualified
 - 7 -

export receivables by CVI would result in recognition of income

by CV at the time of the purchases, a plan was developed during

September 1982 by CV's tax department and its outside

accountants, Price Waterhouse, both to avoid recognition of

income from the purchase of qualified export receivables and to

maintain CVI's status as a DISC (the plan). Under the plan, when

CV became obligated to pay CVI the proceeds collected with

respect to CVI’s interest in the qualified export receivables on

September 30, 1982, CVI would use the proceeds of the investment

to fund demand loans to CV that would not be "qualified export

assets" within the meaning of section 993(b). CVI would call

those loans prior to the end of its taxable year and use their

proceeds to (1) purchase qualified export receivables, (2)

reimburse CV for export promotion expenses incurred on behalf of

CVI, and (3) pay a dividend to CV. It was expected that the

execution of the plan would cause CVI to satisfy the 95 percent

of assets test provided by section 992(a)(1)(B) at the close of

its taxable year. The plan was approved by Mr. Krieger and Mr.

Spindler. By purchasing CV's qualified export receivables at the

end of January of 1983, CVI sought to minimize the amount of the

receivables that might be paid before the end of its taxable year

because the conversion of the receivables to cash could have

caused CVI to fail the 95 percent of assets test.

The following series of events occurred pursuant to the

plan. First, CVI made demand loans to CV on the following dates
 - 8 -

in 1982 in the following amounts:

Date Amount of Loan

Sept. 30 $27,272,888.00
Oct. 29 1,142,311.00
Nov. 1 1,135,689.50
Nov. 16 1,046,278.76
Dec. 1 1,099,944.32

Then, on January 27, 1983, CVI made written demand for payment of

both the principal amounts of the loans (viz, $31,697,111.58) and

accrued interest thereon (viz, $1,386,326.55), which totaled

$33,083,438.13. On January 31, 1983, the following occurred: (1)

CV wired the sum to CVI in full payment of the principal amounts

and interest, and the sum was deposited in CVI's account with the

First National Bank of Boston; (2) CVI received the proceeds of

two maturing time deposits, totaling $5,663,970.38, that were

also deposited on that date in the account; (3) CVI wired both

the payment it had received from CV and the proceeds of the

maturing time deposits to CV, transferring a total of

$38,747,408.51.

The receipt by CVI of the proceeds of its maturing time

deposits was recorded in its general ledger by entries recorded

and approved between January 20, 1983, and January 25, 1983. The

repayment by CV of CVI's demand loans and the subsequent transfer

of funds by CVI to CV described above were recorded in CVI's

general ledger by entries prepared and approved on January 31,

1983. For accounting purposes, the transfers between CV and CVI

were recorded as passing through an account designated
 - 9 -

"intercompany account".

On January 31, 1983, and prior to the application of the

above-described payment by CVI to CV, CV held qualified export

receivables as described in the master receivables purchase

agreement and CVI was indebted to CV (1) pursuant to the export

promotion agreement for expenses that previously had been paid by

CV but had not yet been reimbursed by CVI and (2) for accrued

State taxes that would be paid by CV in the first instance. At

the time CVI wired the payment to CV, both CV and CVI intended

that CVI would (1) purchase from CV the receivables of CV that

were outstanding at the close of business on January 31, 1983,

(2) reimburse CV for the aforementioned expenses, (3) pay CV an

amount equal to the accrued State taxes, and (4) pay a dividend

to CV from a portion of the transferred funds.

All events necessary to determine the total amount of the

receivables, expenses, and taxes had taken place by the close of

business on that date; however, the information necessary to

compute the total amount of the items was not available to CV and

CVI's tax and accounting departments on that date. In prior

years, CVI regularly had reimbursed CV for export promotion

expenses pursuant to the export promotion agreement and for State

tax payments. Additionally, CVI's and CV's tax and accounting

departments did not have available to them on January 31, 1983,

the information necessary to compute the amount of the dividend

CVI intended to pay CV. At the time CVI made the foregoing
 - 10 -

transfers to CV, neither CVI nor CV intended that any portion of

the funds transferred would be repaid to CVI.

By February 23, 1983, CV's and CVI's tax and accounting

departments had received the information necessary to compute the

outstanding balance of CV's qualified export receivables and the

amount of unreimbursed export promotion expenses as of January

31, 1983, and to prepare the documents memorializing the

transactions. On or about that date, an agreement entitled

"Purchase of Qualified Accounts Receivable Agreement", dated

effective as of January 31, 1983, provided for CVI's purchase

from CV of qualified export receivables in the aggregate face

amount of $24,027,770 at a discount of $1,541,782, resulting in a

purchase price of $22,485,988. All of the receivables purchased

thereby were qualified export assets within the meaning of

section 993(b). The amount CVI owed CV as expense reimbursements

under the export promotion agreement was $2,570,631, and the

amount of accrued State tax CVI owed CV was $228. A portion of

the funds CVI transferred to CV on January 31, 1983, was applied

to reimburse CV for the expenses and taxes.

Also on or about February 23, 1983, an "Action of Directors

In Lieu of a Meeting" was signed by the directors of CVI in which

it was voted as of January 31, 1983, to pay CV a dividend of

$13,690,561, the difference between (1) the amount of funds CVI

wired to CV on January 31, 1983 (viz, $38,747,408), and (2) the

sum of (a) the aggregate purchase price of the receivables
 - 11 -

purchased by CVI (viz, $22,485,988), (b) the amount CVI owed CV

as expense reimbursements under the export promotion agreement

(viz, $2,570,631) and accrued State tax.

The foregoing transactions were recorded in CVI's general

ledger by entries that were prepared and approved after January

31, 1983, but prior to the time CV and CVI closed their books in

accordance with their usual accounting practice.

With respect to CVI's taxable year ending January 31, 1984,

the following series of events occurred pursuant to the plan that

had been developed in September 1982. CVI made demand loans to

CV on the following dates in 1983 in the following amounts:

Date Amount of Loan

Mar. 31 $4,694,145
Aug. 29 28,552,907
Oct. 31 3,365,590

Subsequently, on January 27, 1984, the following occurred: (1)

CVI made written demand for payment of both the principal amounts

of the foregoing loans (viz, $36,612,642) and accrued interest

thereon (viz, $1,797,153), which totaled $38,409,795; (2) CV

wired $38,409,795 to CVI in full payment of the principal amounts

and interest on the foregoing loans, and the payment was

deposited in CVI's account with the First National Bank of

Boston; and (3) CVI wired $38,409,795 to CV.

The foregoing transfers were recorded in CVI's general

ledger by entries that were prepared and approved on or before

February 15, 1984, but before CV and CVI closed their books for
 - 12 -

the month of January 1984 in accordance with their usual

accounting practice. For accounting purposes, not all of the

sums transferred between CV and CVI were recorded as passing

through the "intercompany account" because the entries used to

record the foregoing transactions were more simplified than those

used to record the corresponding transfers that had occurred in

January 1983.

On January 27, 1984, and prior to the application of the

above-described payment by CVI to CV, CV held qualified export

receivables as described in the master receivables purchase

agreement and CVI was indebted to CV (1) pursuant to the export

promotion agreement for expenses that previously had been paid by

CV but had not yet been reimbursed by CVI and (2) for accrued

State taxes that would be paid by CV in the first instance. At

the time CVI wired the payment to CV, CV and CVI intended that

CVI would (1) purchase from CV receivables that were outstanding

at the close of business on January 31, 1984, (2) reimburse CV

for the aforementioned expenses, (3) pay CV an amount equal to

the accrued State taxes, and (4) pay a dividend to CV from a

portion of the transferred funds. All events necessary to

determine the total amount of the receivables, expenses and taxes

as of that date had taken place by the close of business on that

date; however, the information necessary to compute the total

amount of the items was not available to CV's or CVI's tax and

accounting departments by the close of business on January 31,
 - 13 -

1984. Additionally, CVI's and CV's tax and accounting

departments did not have available to them on January 31, 1984,

the information necessary to compute the amount of the dividend

CVI intended to pay CV. At the time CVI made the foregoing

transfers to CV, neither CVI nor CV intended that any portion of

the transfers would be repaid to CVI.

By February 15, 1984, CVI's and CV's tax and accounting

departments had received the information necessary to compute the

outstanding balance of qualified export receivables and the

amount of unreimbursed export promotion expenses as of January

31, 1984. On or about February 15, 1984, an agreement entitled

"Purchase of Accounts Receivable Agreement" was executed and

dated as of January 31, 1984. The agreement provided for CVI's

purchases from CV of qualified export receivables having an

aggregate face amount of $33,517,418 at a discount of $2,151,817,

for an aggregate purchase price of $31,365,601. All of the

receivables purchased pursuant to the agreement were qualified

export assets within the meaning of section 993(b).

Also on or about February 15, 1984, an "Action of Directors

in Lieu of a Meeting" was signed by each of CVI's directors in

which it was voted to pay as of January 31, 1984, a dividend of

$5 million to CV. The amount of the dividend is equal to the

difference between (1) the amount of funds CVI wired to CV on

January 27, 1984, (viz, $38,409,795), and (2) the sum of (a) the

aggregate purchase price for the receivables purchased by CVI
 - 14 -

(viz, $31,365,601), (b)(i) the amount of expense reimbursements

CVI owed CV under the export promotion agreement as of that date,

and (ii) accrued State taxes (viz, $228), and (c) an unapplied

balance of $228.

The foregoing transactions were recorded in CVI's general

ledger by entries that were prepared and approved after January

31, 1984, but prior to the time CVI and CV closed their books for

the month of January in accordance with their usual accounting

practice.

For the period January 31, 1982, through January 31, 1984,

no security agreement was executed with respect to the qualified

export receivables sold, nor was any financing statement filed.

Computation of DISC Commission

For each of CVI’s taxable years ending January 31, 1983 and

1984, and December 31, 1984 (taxable years in question),

petitioners computed the commission payable to CVI using the 50

percent of combined taxable income method (50 percent of CTI

method) provided pursuant to section 994(a)(2), allocating a

ratable portion of gross interest expense to qualified export

receipts by product line for purposes of the method.

Stock Warrant Issue

Background

Prior to May 1983, CV decided that, in order to meet its

customers’ needs, it required a new, more advanced computer
 - 15 -

workstation4 on which to run its CAD/CAM software. Its customers

desired a computer workstation with an “open system environment”

that would enable its user to run software other than CV’s. To

CV, the change to such a system was a significant strategic

change because CV previously had sold products based only upon

its own closed proprietary operating systems. An additional

significant strategic change for CV was the decision to purchase

its workstations from a vendor, rather than to manufacture them

itself, because manufacturing workstations had been its primary

activity up to such time. Due to its large investment in

manufacturing assets, however, CV needed be able to continue

manufacturing. CV sought to establish a long-term relationship

with a supplier for the design and manufacture of its new

workstation.

Two manufacturers, Apollo Computer, Inc. (Apollo), an

established firm in the computer workstation industry, and Sun

Microsystems, Inc. (Sun), a smaller competitor, submitted bids to

CV for such a workstation in response to a solicitation by CV.

In a May 9, 1983, letter to CV, Sun acknowledged that it might

not be able to produce workstations in quantities sufficient to

meet CV’s demands, and indicated that it would be willing to

4

A computer workstation is a desktop computer utilized by
scientists or engineers that performs complex computing tasks
using its own computing power rather than that of a central
computer shared with other users. Workstations, however, may be
linked together to form a network.
 - 16 -

grant CV the right to manufacture the workstations were Sun’s

capacity insufficient. Sun also set forth its method of

discounting purchases, which was to allow a 36-to 40-percent

discount from the list price of a product for purchases of

between $10 million and $30 million, and a 40-percent discount

for purchases above $30 million. In a May 11, 1983, letter to

CV, Sun made reference to a “maximum Computervision discount” of

45 percent.5 Neither letter discussed stock warrants.

Although CV made a preliminary decision to select Apollo as

its vendor, CV continued to consider Sun because (1) Sun

possessed valuable technology and know-how with respect to UNIX,

a nonproprietary, open computer operating system that CV believed

was best suited to provide the open system environment desired by

its customers, but with which CV did not have experience, and (2)

Sun aggressively pursued the business. CV decided to propose to

Sun a technology sharing arrangement under which CV and Sun would

jointly develop a workstation using Sun’s technology and the UNIX

operating system. Also, in order to both allow CV to manufacture

workstations and assure Sun that CV would purchase workstations

manufactured by Sun and would not manufacture all the

workstations itself, CV decided to propose to Sun a “reverse

5

Such discount apparently represented the sum of the maximum
quantity discount from list price offered by Sun (viz, 40
percent) and the discount allowed for early payment (viz, 5
percent).
 - 17 -

royalty” arrangement under which CV could manufacture

workstations but would be discouraged from being its primary

manufacturer because the “royalty” paid Sun with respect to the

workstations would increase as the number of workstations

manufactured by CV increased.

During June 1983, representatives of CV and Sun met to

discuss the proposals and to develop the framework for their

business relationship. During the negotiations, CV sought to

minimize the price at which it would purchase workstations by

maximizing the discount from Sun’s list price for Sun’s products,

and Sun sought to maximize the selling price of the workstations,

and sought to minimize the discount from its list price. CV

pressed for a higher discount although it was aware that, in the

computer industry, a 45-percent discount was on the high end of

normal purchase discounts given by suppliers to original

equipment manufacturers (OEM’s). Near the conclusion of the June

1983 meeting, CV and Sun discussed giving CV warrants to purchase

Sun stock as means of reducing the cost to CV of the transaction

with Sun.

The Preliminary Agreement

The negotiations culminated in an agreement that was signed

on or about June 17, 1983 (June 17, 1983, agreement), and that

established guidelines for the joint development and manufacture

of workstations by CV and Sun. The June 17, 1983, agreement

provided that the relationship between CV and Sun was to
 - 18 -

encompass: (1) An exchange of current product technologies; (2)

cooperation on future product development; (3) sharing of field

support services and facilities; (4) investment participation in

Sun by CV; and (5) the basis for use of mutually owned designs

and manufacturing implementations. The terms regarding the

purchase of workstations themselves were “subject to the terms

and conditions of a separate OEM contract to be negotiated

between the parties”. Consummation of the transactions outlined

in the agreement was subject to a number of conditions, including

the signing of definitive agreements implementing the basic

understanding set forth in the June 17, 1983, agreement.

The June 17, 1983, agreement contemplated that Sun would

grant to CV two stock warrants and a convertible debenture

(debenture). The first warrant was to be exercisable if, within

a 36-month period, CV had transacted $20 million of business with

Sun, consisting of purchases of Sun-manufactured products and

royalties paid by CV. The second stock warrant (second warrant)

was to be exercisable if CV’s business with Sun (computed on the

same basis) reached a level of $30 million within the same 36-

month period.6 Sun regarded the warrants as an incentive for CV

6

The June 17, 1983, agreement provided in relevant part:

(E) Investment Participation in Sun by CV

--Warrants (5 Year)

(continued...)
 - 19 -

to purchase workstations from Sun. Sun believed that it was

unlikely that the parties would have agreed on the June 17, 1983,

agreement, or that the transactions outlined therein would have

been consummated, without the warrants.

Additionally, concerning a $2.5 million loan made to Sun by

CV, the June 17, 1983, agreement provided for the issuance of a

5-year, 8-percent, $1.5 million debenture convertible into

100,000 shares of Sun common stock, and a $1 million

nonconvertible note.7

6
(...continued)
(a) On 100,000 shares of common stock at $12.00/share,
exercisable after CV has received $20 million of Sun-
manufactured product plus royalties paid by CV within 36
months after 1st production CV delivery for revenue.

(b) On 100,000 share[s] of common stock at
$15.00/share exercisable after CV has received $30 million
of Sun-manufactured product plus royalties paid by CV within
36 months of 1st production CV delivery for revenue.

7

The June 17, 1983, agreement provided in relevant part:

--Debenture

A $1.5 million debenture (5 year 8%) convertible into
100,000 shares of common stock, in conjunction with a $1.0
million loan at 8%, such loan to be repaid quarterly at the
rate of 10% of the previous three months invoices to CV
until the loan is repaid in full. (i.e., after $10 million
in invoices)
 - 20 -

The Definitive Agreements

On or about November 22, 1983, CV and Sun executed the

following three agreements (agreements): A purchase agreement

(purchase agreement), pursuant to which Sun agreed, inter alia,

to sell CV certain workstations on certain terms and conditions

and CV agreed, inter alia, to abide by the terms and conditions

in the event it purchased any workstations from Sun; an Agreement

Relating to Investments by Computervision Corporation in Sun

Microsystems, Inc. (investment agreement), which related, inter

alia, to the warrants and the debenture to be issued by Sun to

CV; and a joint development agreement (joint development

agreement), which related, inter alia, to the joint development

of certain computer products and provided for the $1 million loan

referred to in the June 17, 1983, agreement. The division of the

respective undertakings of CV and Sun into separate agreements

had no particular significance, and the parties viewed the

agreements as a single integrated agreement.

Pursuant to the terms of the purchase agreement, as set

forth in the exhibit entitled "Volume Pricing Terms", CV was

allowed an "across the board" discount of 40 percent on all

purchase orders for the first 6 months, and after that, a maximum

volume discount of 40 percent off list price. The purchase

agreement, which ran for a period of approximately 3 years,

contained no reference to the warrants. It also provided the
 - 21 -

"The Joint Development Agreement shall prevail over this

Agreement." The purchase agreement also stated that

[CV] shall get the benefit of lower prices that
are given to other customers of * * * [Sun] for current
and future products that are sold on terms and
conditions that are the same as the terms and
conditions offered to * * * [CV]. If * * * [Sun] does
not offer * * * [CV] a price equal to the lowest price
being offered to such other customer of * * * [Sun]
because the terms and conditions being offered to that
customer are different from those offered to * * *
[CV], * * * [CV] shall have the option to accept the
lower price on the same terms and conditions as are
being offered to the other customer. Terms and
conditions shall include, but not be limited to, such
items as payment terms, manufacturing rights,
quantities, technology exchanges, warranties and up-
front investment by a purchaser.

Pursuant to the investment agreement, Sun agreed to issue

two stock warrants to CV to provide a further "incentive for an

ongoing business relationship." The exercise of the first stock

warrant was contingent upon CV’s purchase of $20 million of

products (including royalties paid by CV to Sun pursuant to the

joint development agreement) within 36 months of the first

shipment by Sun to CV; the exercise of the second warrant

required $30 million of purchases within the same 36-month

period. The stock warrants were exercisable in whole or in part

at any time within 5 years after they first became exercisable.

The investment agreement provided in relevant part:

Sun and CV have entered into a Joint Development
Agreement of even date * * * providing for the sharing
by the parties of certain technologies, for the
manufacture by CV of certain reasonable workstation
 - 22 -

configurations ("RWCs") and for the purchase by CV from
Sun of RWCs. In recognition of their mutual
expectation of a continuing business relationship of
value to both parties, CV has indicated its willingness
to make certain loans to Sun and Sun has indicated its
willingness to grant to CV an equity participation in
Sun.

* * * * * * *

3. The Warrants. As additional incentive for an
ongoing business relationship, Sun is issuing to CV (a)
a warrant to purchase 10,000 shares of Sun’s Series F
Preferred Stock at a price of $120.00 per share, such
warrant to become exercisable on the day after the
Cumulative Sun Business with CV (referred to below)
exceeds $20 million if such figure is reached within 36
months of the date of the first shipment by CV of a
First Generation RWC (as defined in the Joint
Development Agreement) for revenue and (b) a warrant to
purchase 10,000 shares of Sun’s Series G Preferred
Stock at a price of $150.00 per share, such warrant to
become exercisable on the day after the Cumulative Sun
Business with CV exceeds $30 million if such figure is
reached within the 36 month period mentioned in (a)
above. * * * Definitions of "Cumulative Sun Business
with CV" and of the first shipment by CV of a unit for
revenue appear below.

4. Cumulative Sun Business with CV. The Cumulative
Sun Business with CV, which determines the
exercisability of the Warrants as provided above, shall
be the aggregate cumulative sum of (i) the amount of
Sun’s invoices (net of freight, insurance, duty, taxes
and returned products) to CV for Sun products purchased
by CV under the Purchase Agreement (as defined below),
and (ii) royalties payable by CV to Sun pursuant to
Section 5 of the Joint Development Agreement.

* * * * * * *

(b) The shipment by CV of a First Generation RWC for
revenue refers to the first bona fide regular way
placement of such a unit by CV with an independent
customer, whether such unit be placed on sale or lease
terms. The use by CV of units internally, including
units used by its subsidiaries, shall not be regarded
 - 23 -

as shipments for revenue. CV will give Sun written
notice of the date of the first shipment of such First
Generation RWC for revenue within 30 days after such
shipment.

* * * * * * *

ANNEX II

10,000 Shares Series F/G Preferred Stock

* * * * * * *

Preferred Stock Purchase Warrant

SUN MICROSYSTEMS, INC. ("Sun"), a California
corporation, hereby certifies that, for value received,
COMPUTERVISION CORPORATION ("CV"), or permitted assigns, is
entitled, subject to the terms set forth below, to purchase from
Sun at any time or from time to time after the Initial Exercise
Date and before * * * the Expiration Date, 10,000 fully paid and
nonassessable shares of Series F/G Preferred Stock of Sun, at the
purchase price per share of [$120/150] * * * The number and
character of such shares of Preferred Stock and the purchase
price per share are subject to adjustment as provided herein.

This Warrant is one of the Preferred Stock Purchase
Warrants (the "Warrants") issued in connection with an
Agreement Relating to Investments by Computervision
Corporation in Sun Microsystems, Inc. dated November
21, 1983, (the "Investment Agreement"). The Warrants
evidence rights to purchase an aggregate of 10,000
shares of Series F Preferred Stock and 10,000 shares of
Series G Preferred Stock of Sun * * *

CV had not invested in a supplier prior to the transaction

with Sun described above. CV did not make a practice of

investing in its suppliers and did not view the warrants as an

investment in Sun.

The linking of CV’s ability to exercise the warrants to the

dollar volume of business CV transacted with Sun served as an
 - 24 -

incentive for CV to do business with Sun. The warrants served as

an incentive to CV to purchase workstations manufactured by Sun,

rather than to manufacture the workstations itself, during the

initial phase of the transaction between CV and Sun. For

workstations manufactured by Sun, the purchase agreement provided

a higher price to be paid by CV to Sun than the royalties that CV

was obligated to pay Sun for workstations manufactured by CV.

Consequently, the volume purchase levels at which the warrants

became exercisable would be reached more quickly were CV to

purchase workstations manufactured by Sun than would be the case

if CV were to manufacture them itself and pay royalties to Sun.

The dollar volume of business at which the warrants became

exercisable was within the expected dollar volume of business to

be transacted between CV and Sun. Although CV did not commit to

buying the volume specified in the investment agreement for

exercisability of the warrants, its projections furnished to Sun

indicated that CV believed it would be able to effect purchases

at those volume levels.

The joint development agreement contained provisions

implementing the objectives of CV and Sun with respect to the

development of future products. As noted above, Sun possessed

valuable technology and know-how with respect to the operation of

UNIX, an open computer operating system compatible with hardware

and software developed by companies besides CV and with which CV
 - 25 -

did not have experience. CV intended to develop software for

future products, and it was necessary for CV to coordinate such

advancement with the development of the workstations by Sun.

Further, the parties had to develop an appropriate interface

between the systems in order to facilitate the use of Sun’s

workstations with CV’s existing product line. They also agreed

to contribute mutually to the design of new workstation products.

The parties agreed to broadly share all current product

information and knowledge relating to development of future

products and to exchange specific items such as hardware and

software. The joint development agreement also specified the

royalties to be paid by CV for Sun’s technology. It also gave CV

the right to manufacture workstations if Sun did not supply them

under the purchase agreement. Finally, although there was no

commitment to purchase any minimum volume of workstations, CV

agreed to purchase 50 percent of its workstation requirement from

Sun during the 3-year term of the purchase agreement. The joint

development agreement also stated that

9. CV Investment in Sun. The parties are entering
into a separate Agreement Relating to Investments by
* * * [CV] in Sun Microsystems, Inc. which provides for
loans by CV to Sun and investments by CV in Sun.

The Warrants and the Debt Financing

Both at the time of the negotiations and when the agreements

were entered into, neither CV nor Sun knew the extent, if any, to
 - 26 -

which the stock warrants would appreciate in value, although CV

hoped that Sun would be successful and believed that Sun had the

potential to be successful. Sun obtained an independent

appraisal of the fair market value, as of November 21, 1983, of

the stock warrants. The appraisal estimated the fair market

value of the warrant to purchase series F preferred stock to be

$146,000 and the fair market value of the warrant to purchase

series G preferred stock to be $58,000. The appraisal was made

by the investment banking firms of Robertson, Colman & Stephens

and Alex, Brown & Sons, Inc. and is set forth in a letter dated

March 28, 1984. CV did not acquire Sun stock pursuant to the

warrants, but instead ultimately sold the warrants in 1986 and

1987 to underwriters.

During its 1984 fiscal year, Sun had an unsecured working

line of credit pursuant to which it could borrow up to $8 million

at a rate of interest equal to prime plus .75 percent. Sun also

had a $3 million loan commitment from banks that provided for

interest equal to the prime rate plus 1 percent. The prime rate

in May and June 1983 was 10.5 percent, and, on December 2, 1983,

it was 11 percent.

During its negotiations with CV, Sun tried to obtain $5

million of financing from CV. CV, which had a large cash

reserve, would only agree to loan $2.5 million to Sun; the

financing consisted of the $1.5 million debenture that was
 - 27 -

convertible and was subordinated to the extent and in the manner

set forth therein to "all Sun’s Senior Indebtedness" (as defined

therein), and a $1 million note. The form of the debenture

attached to the Investment Agreement as Annex I defined "Senior

Indebtedness" as:

the principal of (and premium, if any) and unpaid
interest on, (i) indebtedness of Sun, whether
outstanding on the date hereof or hereafter created, to
banks, leasing companies, insurance companies or other
lending institutions, regularly engaged in the business
of lending money, which is for money borrowed by Sun or
a subsidiary of Sun, whether or not secured, or
equipment leased by Sun or a subsidiary of Sun and (ii)
any deferrals, renewals or extensions of any such
indebtedness.

The debenture was also not entitled to a sinking fund. The

terms of the debenture, issued on December 1, 1983, required Sun

to pay $1.5 million to CV on or before December 1, 1988, with

interest accruing on the unpaid balance at the rate of 8 percent

per year. The principal amount of the debenture was convertible

into Sun’s series G preferred stock at a price equal to $150 per

share. CV acquired common stock in Sun in conversion of the

debenture and recognized gain on the sale of that stock in 1986

and 1987.8

Sale of the Warrants

On March 4, 1986, Sun made its initial public offering of

its common stock. Subsequently, pursuant to the agreements, each

8

It appears that the preferred stock that CV was entitled to
receive pursuant to the debenture was converted into common
stock, as was the case with the stock CV became entitled to
receive pursuant to the warrants as discussed below.
 - 28 -

share of the Sun preferred stock covered by the stock warrants

issued to CV was converted into 15 shares of Sun common stock.

Consequently, for each of the two stock warrants, CV had the

contingent right to purchase 150,000 shares of Sun common stock.

The first warrant to purchase Sun common stock (at a price

of $8 per share, derived by dividing the original exercise price

of $120 per share of series F preferred stock by 15,

corresponding to the 15-to-1 conversion ratio referred to above)

became exercisable in the fourth quarter of Sun’s 1986 fiscal

year (i.e., April through June 1986) and was exercised on

November 24, 1986. On that date, CV sold its rights to the first

warrant to an underwriter, who then exercised the first warrant.

The closing sale price of Sun common stock as reported in the

NASDAQ National Market System on November 24, 1986, was $19.375

per share, or $11.375 per share greater than the $8-per-share

exercise price.

During January 1987, the second warrant became exercisable

by CV (at a price of $10 per share, derived by dividing the

original exercise price of $150 per share of series F preferred

stock by 15, corresponding to the 15-to-1 conversion ratio

referred to above). CV sold its rights to the second warrant

(the "second warrant") to an underwriter on March 12, 1987. The

closing sale price of Sun common stock as reported in the NASDAQ

National Market System on March 11, 1987, was $31.375 per share,

$21.375 greater than CV’s $10-per-share exercise price. CV

received a net amount of $3,002,750 in proceeds from sale of the
 - 29 -

second warrant, after taking into account underwriting costs and

other expenses of the sale.

Tax Return and Financial Reporting Treatment of the Sale of
the Warrants

On its Federal income tax return for its 1987 taxable year,

CV reported part of the gain on disposition of the second warrant

as a reduction in its cost of goods sold and part as a long-term

capital gain. CV computed a capital gain from the sale of the

second warrant of $1,179,578 by subtracting from the $3,002,750

net sale proceeds an "adjusted basis" of $1,823,172. The

“adjusted basis” represented the amount that CV would have

realized had it disposed of the second warrant when the warrant

first became exercisable and which CV treated in its tax return

as a reduction in CV’s cost of goods sold (i.e., as a discount in

the price paid by CV for goods purchased from Sun).

On its Form 10-Q for the quarter ended March 31, 1987, filed

with the Securities and Exchange Commission (SEC), CV reported a

$4.7 million gain

from the sale of stock and warrants that had been received
in conjunction with a convertible loan and a volume purchase
agreement. The portion of the gain attributable to the
volume purchase rebate ($1.4 million) was accounted for as a
favorable purchase price variance and included in the cost
of goods sold. The remaining $3.3 million gain on the sale
of stock and warrants has been reflected in other income
(net).

On its Form 10-Q for the quarter ended June 30, 1987, filed

with the SEC, CV also reported that it had received during the

first quarter of the year gain from the sale of common stock and

warrants that had been received in conjunction with a convertible
 - 30 -

loan and volume purchase agreement. The Form 10-Q reported that

the portion of the gain attributable to the volume purchase

agreement ($1.4 million) had been accounted for as a favorable

purchase price variance and included in cost of goods sold.

OPINION

DISC Qualification Issue

The first issue that we address is whether CVI qualifies as

a DISC pursuant to section 992(a)(1)9 for each of its relevant

taxable years.

In Computervision Corp. v. Commissioner, 96 T.C. 652, 656

(1991), we stated:

In general, a corporation that qualifies as a DISC

9

Sec. 992(a)(1) provides as follows:

DISC.--For purposes of this title, the term “DISC” means,
with respect to any taxable year, a corporation which is
incorporated under the laws of any State and satisfies the
following conditions for the taxable year:

(A) 95 percent or more of the gross receipts (as
defined in section 993(f)) of such corporation consist of
qualified export receipts (as defined in section 993(a)),

(B) the adjusted basis of the qualified export assets
(as defined in section 993(b)) of the corporation at the
close of the taxable year equals or exceeds 95 percent of
the sum of the adjusted basis of all assets of the
corporation at the close of the taxable year,

(C) such corporation does not have more than one class
of stock and the par or stated value of its outstanding
stock is at least $2,500 on each day of the taxable year,
and

(D) the corporation has made an election pursuant to
subsection (b) to be treated as a DISC and such election is
in effect for the taxable year.
 - 31 -

is not taxable on its profits. * * * Instead, the
DISC's shareholder is taxed each year on a specified
portion of the DISC's earnings and profits as deemed
distributions, while the remaining portion of profits
is not taxed until actually withdrawn from the DISC or
until the erstwhile DISC ceases to qualify as a DISC.
* * *
To ensure that a DISC’s tax-deferred profits are
used for export activities, Congress provided strict
requirements for qualification as a DISC. * * *

* * * * * * *

Because of minimal capitalization and
organizational requirements, a DISC may be no more than
a corporation that serves primarily as a bookkeeping
device to measure the amount of export earnings that
are subject to tax deferral. [Citation omitted.]

In that case, we concluded that CVI was organized and

operated solely as an accounting device for computing income

subject to deferral under the DISC provisions. Id. at 670.

Based on the record in the instant case, we similarly conclude

that CVI was merely an accounting device to defer taxation of

income during the taxable years in issue by qualifying as a DISC.

The parties agree that the only question in dispute

concerning CVI’s qualification as a DISC for its relevant taxable

years is whether the adjusted basis of CVI's qualified export

assets exceeded 95 percent of all of its assets at the close of

those taxable years (95 percent of assets test). Sec.

992(a)(1)(B). The parties further agree that resolution of that

question depends solely upon whether CVI's transfers of funds to

CV prior to the close of each of those years were effective to

complete (1) the purchase from CV of qualified export

receivables, (2) the reimbursement of CV for certain expenses,
 - 32 -

and (3) the payment of a dividend to CV prior to the close of

those taxable years. The parties agree that, in the event the

transfers were effective to complete the foregoing, CVI satisfied

the 95 percent of assets test as of the close of each of its

relevant taxable years.

Petitioners contend that the transfers in issue effected the

purchase of qualified export receivables and the transfer of

ownership of the cash used to reimburse CV for certain expenses

and to pay dividends to CV, so that CVI's assets as of the close

of its relevant taxable years did not include the funds

transferred to CV but did include the receivables purchased with

a portion of the funds. Petitioners further contend that the

actions taken subsequent to the end of each of CVI's relevant

taxable years, when the information necessary to ascertain the

amount of receivables purchased became available, merely

memorialized or documented the transactions that had taken place

before the end of each year.

Respondent, however, contends that the actions taken before

the close of each of CVI's relevant taxable years were not

sufficient to effect the purchase of CV’s qualified export

receivables, the reimbursement of expenses incurred by CV, and

payment of dividends to CV, but that CV and CVI merely had an

intention to do such things at the close of each of CVI’s

relevant taxable years which was not carried out until after the

close of each of those years, when the final steps of each

transaction were carried out. Consequently, respondent maintains
 - 33 -

that CVI's assets as of the close of each year included an open

account of, or loan to, CV, equal to the amount of funds

transferred, which was not a qualified export asset of CVI and

that, therefore, CVI failed to satisfy the 95 percent of assets

test as of the close of each of its relevant taxable years.

We consider whether, for purposes of the 95 percent of

assets test for each of CVI's relevant taxable years, CVI's

assets included qualified accounts receivable purchased from CV

or an open account equal to the amount of funds transferred from

CVI to CV on each of January 31, 1983, and January 27, 1984.

Resolution of that question depends upon whether a completed sale

of the receivables occurred prior to the close of each of CVI's

relevant taxable years.

Petitioners contend that so-called "relaxed ownership

requirements" with respect to the acquisition by a DISC of an

interest in its parent's accounts receivable, such as were

announced by the Commissioner in Rev. Rul. 75-430, 1975-2 C.B.

313, means that arrangements less formal than may be customary

are sufficient to effect the purchase of receivables for purposes

of the 95 percent of assets test. We, however, do not find the

ruling on point because it concerns only the question of whether

a DISC's interest in receivables is sufficient for the

receivables to be considered qualified export assets of the DISC

for purposes of the 95 percent of assets test; it does not

address the time at which a transfer of ownership occurs.

In Derr v. Commissioner, 77 T.C. 708, 723-724 (1981), we set
 - 34 -

forth the following approach to resolve the issue of when a sale

is complete:

For purposes of Federal income taxation, a sale
occurs upon the transfer of the benefits and burdens of
ownership rather than upon the satisfaction of the
technical requirements for the passage of title under
State law. The question of when a sale is complete for
Federal tax purposes is essentially one of fact. The
applicable test is a practical one which considers all
the facts and circumstances, with no single factor
controlling the outcome. [Citations omitted.]

See also J.B.N. Tel. Co., Inc. v. United States, 638 F.2d 227,

232 (10th Cir. 1981); Rich Lumber Co. v. United States, 237 F.2d

424, 427 (1st Cir. 1956); Guardian Indus. Corp. v. Commissioner,

97 T.C. 308, 318 (1991), affd. without published opinion 21 F.3d

427 (6th Cir. 1994); Yelencsics v. Commissioner, 74 T.C. 1513,

1527 (1980).

Respondent contends that the sale of CV's qualified export

receivables could not have occurred prior to the close of CVI's

relevant taxable years because the requirements for the transfer

of accounts receivable prescribed by Article 9 of the Uniform

Commercial Code (U.C.C.) as adopted by Massachusetts were not

satisfied. We do not agree. Generally, State law is not

dispositive of whether or when a sale or transfer of property

occurs for Federal tax purposes. Burnet v. Harmel, 287 U.S. 103,

110 (1932); Snyder v. Commissioner, 66 T.C. 785, 792 (1976). As

the Supreme Court has stated:

the revenue laws are to be construed in the light of
their general purpose to establish a nationwide scheme
of taxation uniform in its application. Hence their
provisions are not to be taken as subject to state
control or limitation unless the language or necessary
 - 35 -

implication of the section involved makes its
application dependent on state law. * * * [United
States v. Peltzer, 312 U.S. 399, 402-403 (1941).]

Respondent does not point to any circumstance showing that

Congress intended that a DISC's ability to satisfy the 95 percent

of assets test depends solely upon State law governing the

passage of title, and we are unable to discern any such intent on

the part of Congress. See also Tumac Lumber Co. v. United

States, 625 F. Supp. 1030, 1032 (D. Or. 1985) ("It was not the

intention of the U.C.C. drafters that the U.C.C. should apply to

transactions such as those" involving the assignment of accounts

receivable to a DISC).10

Generally, the time of passage of title under State law,

while highly significant, is only one factor to be considered in

deciding when a sale occurs for Federal tax purposes and is not

controlling. See Morco Corp. v. Commissioner, 300 F.2d 245, 246

(2d Cir. 1962), affg. T.C. Memo. 1961-57; Rich Lumber Co. v.

United States, supra. Where passage of legal title is delayed,

an agreement may still result in a sale of property where,

looking to all of the facts and circumstances, the parties to the

agreement intended the agreement to result in a sale, and the

10

We note that, although the Commissioner’s rulings are not
binding upon this Court, Halliburton Co. v. Commissioner, 100
T.C. 216, 232 (1993), affd. without published opinion 25 F.3d
1043 (5th Cir. 1994), in Rev. Rul. 75-430, 1975-2 C.B. 313, the
Commissioner ruled that accounts receivable transferred to a DISC
by its parent were "qualified export assets" within the meaning
of sec. 993(b)(3) without considering whether the transfer
complied with the applicable provisions of State law.
 - 36 -

agreement transfers substantially all of the accouterments of

ownership. Baird v. Commissioner, 68 T.C. 115, 128 (1977);

Pacific Coast Music Jobbers, Inc. v. Commissioner, 55 T.C. 866,

874 (1971), affd. 457 F.2d 1165 (5th Cir. 1972). In discerning

their intent, we rely on the objective evidence of intent

furnished by the overt acts of the parties to the agreement.

Pacific Coast Music Jobbers, Inc. v. Commissioner, supra; Haggard

v. Commissioner, 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288

(9th Cir. 1956).

Other factors considered in addition to the passage of title

include, inter alia: (1) How the parties to the agreement treat

the transaction; (2) whether the right of possession is vested in

the purchaser; (3) which party to the agreement bears the risk of

loss with respect to the property; and (4) which party to the

agreement receives the profits from the property. Grodt & McKay

Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237-1238 (1981).

With the foregoing in mind, we consider whether the benefits

and burdens of ownership of the qualified export receivables in

issue passed to CVI by January 31 of each of its relevant taxable

years or at a later time. Although, as noted above, State law

(in this case, Massachusetts law) is not controlling as to the

time at which the sales of qualified export receivables occurred,

we consider Massachusetts law as a factor in our analysis.

Respondent, relying on Mass. Ann. Laws ch. 106, sec. 9-102(b)(1)

(Law. Co-op 1984), contends that the time at a which title passes

is governed by the provisions of Massachusetts law embodying
 - 37 -

article 9 of the U.C.C., Mass. Ann. Laws ch. 106, secs. 9-101 to

9-507. (Law. Co-op 1984) (article 9). Respondent, relying on

Mass Ann. Laws ch. 106, sec. 9-203 (Law. Co-op 1984), contends

that a written agreement is required in order to effect a

transfer of ownership under that law, and that the sale of the

qualified export receivables in issue, therefore, did not occur

until each of the written agreements was executed after the close

of each of CVI's relevant taxable years. Petitioners posit, and

we agree, that compliance with the provisions of article 9 was

not necessary to effect a transfer of ownership of the

receivables from CV to CVI by the close of CVI's relevant taxable

years.

A recent commentary by the Permanent Editorial Board for the

U.C.C. addressing this precise question is especially relevant

here. We quote below the pertinent language from PEB Commentary

No. 14, 3B U.L.A. 89-91 (Supp. 1995):

It is a fundamental principle of law that an owner of
property may transfer ownership to another person.
Were a statute intended to take away that right, it
would do so explicitly and such a significant
curtailment of rights would be supported by substantial
reason. No such reason is expressed or implied in * *
* [article 9 of the Uniform Commercial] Code or the
Official Comments. Indeed, the sale of receivables
long antedates adoption of the Code, and it cannot be
supposed that either the drafters of the Code or the
legislatures that enacted it intended to work so
drastic a change in existing law without clearly saying
so. Moreover, a close reading of the text of Article 9
and its Comments, particularly in the context of the
pre-Code history, compels the conclusion that Article 9
does not prevent transfer of ownership.

* * * * * * *
 - 38 -

CONCLUSION

Article 9's application to sales of receivables does
not prevent the transfer of ownership. Official
Comment 2 to * * * sec. 9-102 therefore is amended by
adding the following paragraph:

Neither Section 9-102 nor any other provision
of Article 9 is intended to prevent the transfer
of ownership of accounts or chattel paper. The
determination of whether a particular transfer of
accounts or chattel paper constitutes a sale or a
transfer for security purposes (such as in
connection with a loan) is not governed by Article
9. Article 9 applies both to sales of accounts or
chattel paper and loans secured by accounts on
chattel paper primarily to incorporate Article 9's
perfection rules. The use of terminology such as
"security interest" to include the interest of a
buyer of accounts or chattel paper, "secured
party" to include a buyer of accounts or chattel
paper, "debtor" to include a seller of accounts or
chattel paper, and "collateral" to include
accounts or chattel paper that have been sold is
intended solely as a drafting technique to achieve
this end and is not relevant to the sale or
secured transaction determination. * * * [Fn.
ref. omitted.]

We cannot conclude that the Massachusetts legislature, in

enacting article 9, intended to repeal pre-existing law governing

transfer of ownership of accounts receivable and to create an

exclusive method for effecting such transfers. Under

Massachusetts law, an effective assignment of accounts receivable

may be made orally, and no particular form of words or of conduct

is necessary to constitute such an assignment. Kagan v.

Wattendorf & Co., 3 N.E.2d 275, 278 (Mass. 1936). “A valid

assignment may be made by any words or acts which fairly indicate

an intention to make the assignee the owner of a claim." Id. at

279 (quoting Cosmopolitan Trust Co. v. Leonard Watch Co., 143
 - 39 -

N.E. 827, 829 (Mass. 1924)). An assignment may occur prior to

the execution of a written agreement, if that is the intent of

the parties to the agreement. Id. at 277-279; cf. Rosen v.

Garston, 66 N.E.2d 29, 32-33 (Mass. 1946) (time at which title to

goods sold passes depends on intent of parties to the agreement).

The intent of the parties to the agreement is a question of fact,

to be decided from their declarations, conduct, and motive, and

all the attending circumstances. Casey v. Gallagher, 96 N.E.2d

709, 712 (Mass. 1951). An enforceable agreement, however, does

not arise unless its terms afford a sound basis for (1)

determining when a breach of the agreement could occur and (2)

affording an appropriate remedy to the party aggrieved in the

event of a breach. Louis Stoico, Inc. v. Colonial Dev. Corp.,

343 N.E.2d 872, 875 (Mass. 1976); see also 1 Restatement

Contracts 2d, sec. 33, comment a (1979).

Consequently, we reject respondent’s contention that Mass.

Ann. Laws ch. 106, sec. 9-203 (Law. Co-op 1984), requires a

written agreement in order to effect a sale of accounts

receivable. We, therefore, consider whether, pursuant to general

principles of Massachusetts law, ownership of the qualified

export receivables in issue passed to CVI prior to the close of

its relevant taxable years.

The question we must resolve is whether CV and CVI

adequately manifested an intention that ownership of the

qualified export receivables in issue pass to CVI by the close of

its relevant taxable years and whether a sufficiently definite
 - 40 -

agreement for the transfer of the receivables existed at those

times. Although the manner in which CVI and CV effected the

sales in issue was not perfect, there are sufficient

circumstances in the record to satisfy us that, based on all of

the factors discussed above, sales did in fact occur prior to the

close of CVI’s relevant taxable years.

CV developed a plan in September 1982 to maintain CVI's

status as a DISC by transferring the receivables to CVI by the

close of CVI’s relevant taxable years. A framework for the

purchase of the receivables was furnished by the master

receivables purchase agreement. In pursuance of the September

1982 plan, CVI transferred funds to CV to purchase the

receivables prior to the close of its relevant taxable years, and

written memorials of the transactions were prepared as soon as

the information necessary to compute the amount of receivables

purchased became available. The witnesses at trial credibly

testified that the written agreements covering the sales in issue

simply memorialized the transactions that had occurred during the

relevant taxable years. CV and CVI documented and accounted for

the transactions in a manner consistent with an intent to effect

sales by the close of CVI’s relevant taxable years. Old Colony

Trust Associates v. Hassett, 150 F.2d 179, 182 (1st Cir. 1945);

Baird v. Commissioner, 68 T.C. at 128; Deyoe v. Commissioner, 66

T.C. 904, 911 (1976); Clodfelter v. Commissioner, 48 T.C. 694,

700-701 (1967), affd. 426 F.2d 1391 (9th Cir. 1970). The record

satisfies us that CV and CVI intended the sales of the qualified
 - 41 -

export receivables to take effect prior to the close of CVI’s

relevant taxable years. We have considered respondent’s

contentions with respect to the purported defects in the manner

in which the sales were effected but conclude that petitioners

have nonetheless established that sales of the qualified export

receivables occurred prior to the close of the relevant taxable

years.

We next consider whether the funds CVI transferred to CV

that were used to reimburse CV for export promotion expenses

incurred on behalf of CVI pursuant to the export promotion

agreement and to pay dividends to CV continued to be assets of

CVI after the close of CVI's relevant taxable years. Respondent

contends that the transfers of funds to CV from CVI merely

created "open accounts" or receivables of CVI from CV.

Petitioners contend that ownership of the funds passed from CVI

to CV at the time of their transfer. The question whether a

transfer of property effective for Federal income tax purposes

has been made is a question of fact. Danenberg v. Commissioner,

73 T.C. 370, 390 (1979). The test for deciding whether a

transaction is completed is a practical one, and the transaction

must be viewed in its entirety. Morco Corp. v. Commissioner, 300

F.2d at 246. In deciding whether a transfer has been completed,

we rely upon the objective evidence of intent provided by the

overt acts of the parties to the transfer. Pacific Coast Music

Jobbers, Inc. v. Commissioner, 55 T.C. at 874. Similarly, for

Federal tax purposes, the question of whether a debt has been
 - 42 -

created as a result of a transfer or distribution depends upon

whether, at the time the funds are disbursed, the parties to the

transfer at the time of disbursement, intend that they be repaid.

Crowley v. Commissioner, 962 F.2d 1077, 1079 (1st Cir. 1992),

affg. T.C. Memo. 1990-636; Delta Plastics Corp. v. Commissioner,

54 T.C. 1287, 1291 (1970).

Viewing in its entirety each of the transfers by CVI of

funds insofar as the transfer concerned the export promotion

expenses incurred by, and the dividends paid to, CV, we conclude

that the funds were not assets of CVI as of the close of each of

its relevant taxable years.

One factor we consider is whether, pursuant to Massachusetts

law, title to the funds transferred by CVI to CV passed to CV by

the close of CVI’s relevant taxable years. Massachusetts’ law

provides that possession of property, with the exercise of the

rights of ownership, is evidence of title and ordinarily makes a

prima facie case of title by the possessor. Hurley v. Noone, 196

N.E.2d 905, 908-909 (Mass. 1964). If, however, evidence is

introduced to qualify the evidence of possession, the whole of

the evidence is to be considered together to determine the true

title. Id. at 909. In the instant case, CV was in possession

of, and exercised ownership rights over, all of the cash

transferred by CVI by the close of CVI's relevant taxable years,

and the evidence of CV's possession has not been qualified by any

other evidence in the record indicating that CV was not the owner

of the cash. Accordingly, we conclude that, pursuant to
 - 43 -

Massachusetts law, title to the cash passed to CV by the close of

CVI's relevant taxable years.

The fact that the dividends received by CV were not declared

by the directors of CVI until after the close of CVI’s relevant

taxable years also does not prevent us from concluding that

dividends were effectively paid by the close of those years. As

a general matter, Massachusetts law provides that no dividend can

arise, and shareholders have no right to, or interest in, the

accumulated earnings of a corporation, until the authorized

representatives of a corporation vote to declare a dividend.

Galdi v. Caribbean Sugar Co., 99 N.E.2d 69, 71 (Mass. 1951);

Willson v. Laconia Car Co., 176 N.E. 182, 184 (Mass. 1931);

Joslin v. Boston & M.R. Co., 175 N.E. 156, 158 (Mass. 1931);

Anderson v. Bean, 172 N.E. 647, 652 (Mass. 1930). Although the

distribution of dividends by CVI had not been formally authorized

by the close of its relevant taxable years, an act performed

without authority may be ratified if it could have been

authorized at the time it was performed. It has generally been

held that ratification of an act relates back to the time at

which the act was performed and is equivalent to prior authority

for the act, unless the rights of third parties have intervened.

Tarrants v. Henderson County Farm Bureau, 380 S.W.2d 274, 277

(Ky. 1964); Phillips v. Colfax Co., 243 P.2d 276, 281 (Or. 1952);

Hannigan v. Italo Petroleum Corp. of America, 47 A.2d 169, 171-

173 (Del. 1945); see generally 18B Am. Jur. 2d, Corporations,

secs. 1635-1660, 1657-1658 (1985); 2A Fletcher Cyclopedia of
 - 44 -

Corporations, secs. 750-784 (1992). Consequently, a

corporation’s board may ratify an unauthorized dividend payment,

and, absent intervening rights of third parties, the ratification

is retroactive. Meyers v. El Tejon Oil & Refining Co., 174 P.2d

1, 2-3 (Cal. 1946); Milligan v. G.D. Milligan Grocer Co., 233

S.W. 506, 510 (Mo. Ct. App. 1921). In the instant case, no

intervening rights of third parties intervened between

performance and the subsequent ratification. Although we have

found no Massachusetts case directly on point, it appears to us

that a corporation could effectively ratify a dividend in

Massachusetts under the circumstances of the instant case. See,

e.g., Town of Canton v. Bruno, 282 N.E.2d 87, 93 n.8 (Mass.

1972); Shoolman v. Wales Manufacturing Co., 118 N.E.2d 71, 75

(Mass. 1954); Rochford v. Rochford, 74 N.E. 299, 300 (Mass.

1905); McDowell v. Rockwood, 65 N.E. 65, 67 (Mass. 1902). In the

instant case, the directors of CVI declared dividends effective

as of the last day of each of CVI’s relevant taxable years. We

consider the declarations of dividends to have effectively

ratified the distributions made prior to the close of CVI’s

relevant taxable years.

As with the receivables, State law is only one factor to

consider. Other circumstances surrounding the transfers in issue

also indicate that ownership of the funds transferred to CV

passed to it by the close of CVI’s relevant taxable years. Both

CV and CVI intended that, prior to each transfer, CVI would

continue to qualify as a DISC and would satisfy the 95 percent of
 - 45 -

assets test. Both CV and CVI intended that, prior to the end of

CVI's taxable year, CVI would reimburse CV's export promotion

expenses and pay a dividend with the funds that were not required

to reimburse the expenses and purchase qualified receivables from

CV. CVI transferred funds to CV's possession prior to the end of

each of the taxable years in issue for those purposes. CV

treated those funds as its own, depositing them in its bank

account, and each transfer was recorded on the respective books

of CV and CVI at that time as a payment by CVI to CV, not as a

loan or open account. There were no circumstances contemplated

by the parties under which those funds would be repaid to CVI and

there were no further conditions that CV was required to satisfy

in order to be entitled to those funds. Consequently, we

conclude that the funds were subject to CV's complete dominion

and control at the time they were deposited in its bank account.

Although, by the close of each of CVI's relevant taxable

years, all events had occurred to determine the total amount of

export promotion expenses owed and qualified accounts receivable

to be purchased, that information was not available to CV's and

CVI's tax and accounting departments at that time. That

unavailability was the only circumstance preventing the each of

CVI's payments to CV from being allocated to and among the

expenses reimbursed, the qualified receivables purchased and the

dividends paid. Moreover, under the terms of the export

promotion agreement, CV was required to bill the export promotion

expenses to CVI at the close of CVI's fiscal year, and the amount
 - 46 -

due was payable within 60 days thereafter. Consequently, we

conclude that CVI was obligated to reimburse CV for the export

promotion expenses at the close of its relevant taxable years.

Once the necessary information became available, the appropriate

book entries were prepared, effective as of January 31 of each

year. The making of the entries effective as of each of those

dates, while not conclusive, indicates that the parties intended

the transactions in each of those years to take place on each of

those dates. Deyoe v. Commissioner, 66 T.C. at 911; Clodfelter

v. Commissioner, 48 T.C. at 696, 700-701.

The foregoing circumstances persuade us that CV and CVI

intended that the reimbursement of expenses and payment of

dividends would occur on January 31 of each of CVI’s relevant

taxable years and that the transfers did occur on those dates.

Consequently, we conclude that the payments of expense

reimbursements and dividends occurring prior to the close of

CVI’s relevant taxable years were effective for the purpose of

satisfying section 992(a)(1)(B). Accordingly, we hold that the

funds paid to CV by CVI during CVI’s relevant taxable years that

were used to reimburse export promotion expenses and pay

dividends to CV were not assets of CVI as of the close of those

years for purposes of the 95 percent of assets test of section

992(a)(1)(B) in each of its taxable years ended January 31, 1983

and 1984, and that CVI qualified as a DISC for each of those
 - 47 -

years.11

Computation of DISC Commission

The next issue that we consider is whether, in computing the

commission due CVI from CV for CVI’s taxable years ending January

31, 1983 and 1984, and December 31, 1984,12 using the 50 percent

of CTI method provided by section 994(a)(2) and (b), CV and CVI

are entitled to apportion net, rather than gross, interest

expense among their respective product lines.13 If net interest

expense is apportioned, the combined taxable income (CTI) of CV

and CVI will rise, increasing the commission payable to CVI and

therefore the amount of income on which tax is deferred under the

DISC provisions.

11

Our holding renders it unnecessary to address respondent's
determinations that, in the event CVI does not qualify as a DISC
during its relevant taxable years, the commission income CVI
received from CV for those years should be reallocated to CV
under sec. 482, or, in the alternative, that CVI is taxable on
its income for those years.
12

We note that CVI’s status as a DISC is not in dispute for
its taxable year ending Dec. 31, 1984.
13

The parties agree that, in the event we hold, as we have,
that CVI qualifies as a DISC for its relevant taxable years, that
the computation of the amount of commissions payable to CVI for
those years and the amount of CV’s deduction for those
commissions is governed by our decision in Computervision Corp.
v. Commissioner, 96 T.C. 652 (1991). The parties also agree that
a reduction of $876,993 is necessary in the adjustment reflecting
our holding in Computervision Corp. v. Commissioner, supra, that
respondent made in CV's deduction for DISC commissions payable to
CVI for CVI’s taxable year ending Dec. 31, 1984. Their agreement
is to be taken into account in the Rule 155 computation we order
below.
 - 48 -

Section 994(a) generally provides methods for computing the

transfer price for property sold to a DISC by a related person.

Section 994(a) provides that the transfer price is deemed to be

set at a level that will allow the DISC to derive taxable income

from the sale14 of property to a DISC by a related person equal

to the greatest of, inter alia, 50 percent of the CTI of the DISC

and the person from whom it purchased the property attributable

to the qualified export receipts from the sale of the property

plus 10 percent of the export promotion expenses attributable to

the receipts. Sec. 994(a). The methods provided by section

994(a) are also used to compute the maximum amount of income that

a DISC acting as a commission agent is permitted to earn in a

year. Sec. 1.994-1(d)(2)(i), Income Tax Regs. The 50 percent of

CTI method defines CTI generally as the excess of gross receipts

from a sale of property over the total costs of the DISC and its

related supplier that relate to the sale. Sec. 1.994-1(c)(6),

Income Tax Regs. The regulations further provide:

Costs (other than cost of goods sold) which shall be
treated as relating to gross receipts from sales of
export property are (a) the expenses, losses, and other

14

Although the Internal Revenue Code provides that the
transfer price computation is to be made on a transaction-by-
transaction basis, the regulations promulgated under sec. 994
permit taxpayers to annually elect to group transactions on the
basis of products or product lines for purposes of transfer price
computation. Sec. 994(a); sec. 1.994-1(c)(7)(i), Income Tax
Regs. Petitioners elected to group their export sales
transactions by product lines in each taxable year with respect
to which the DISC commission issue under consideration has been
raised.
 - 49 -

deductions definitely related, and therefore allocated
and apportioned, thereto, and (b) a ratable part of any
other expenses, losses, or other deductions which are
not definitely related to a class of gross income,
determined in a manner consistent with the rules set
forth in * * * [section] 1.861-8, [Income Tax Regs.].
[Sec. 1.994-1(c)(6)(iii), Income Tax Regs.]

Interest is among the expenses subject to apportionment under the

rules set forth in section 1.861-8, Income Tax Regs. Sec. 1.861-

8(e)(2), Income Tax Regs. The regulation apportions interest

“based on the approach that money is fungible and that interest

expense is attributable to all activities and property regardless

of any specific purpose for incurring an obligation on which

interest is paid.” Id. Although the pertinent provisions of

section 1.861-8(e)(2), Income Tax Regs., do not specifically

provide that the interest expense subject to apportionment is the

taxpayer’s interest expense net of interest income, rather than

gross interest expense, we concluded in Bowater, Inc. v.

Commissioner, 101 T.C. 207 (1993), that a taxpayer’s net interest

expense was the appropriate interest expense to be apportioned.

We reasoned that the interest expense net of interest income

represents a taxpayer’s actual cost of borrowing and noted that

interest is assumed to be fungible for purposes of the

regulation. Id. at 211, 214-215. Accordingly, we held that, for

purposes of the 50 percent of CTI method, a taxpayer may

apportion a ratable part of net, rather than gross, interest

expense to its qualified export receipts in calculating CTI. Id.

at 214-215.
 - 50 -

Petitioners contend, and we agree, that CV and CVI are

entitled to apply the holding of Bowater, Inc. v. Commissioner,

supra, in calculating their CTI. Respondent, contending that

Bowater was wrongly decided, urges us to reverse it and hold that

gross, rather than net, interest expense must be apportioned in

computing CTI. We have considered respondent’s arguments, but

decline to overrule our prior case. See Coca Cola Co. & Subs. v.

Commissioner, 106 T.C. __ (1996). Respondent further argues that

a nexus is required between the interest income and expense to be

netted. We do not, however, read the cases that have allowed

netting of interest income against interest expense for purposes

of calculating the interest expense subject to apportionment to

require a nexus between the income and expense, although such a

nexus often may exist. Nor do we consider such a requirement to

be consistent with the approach of section 1.861-8(e)(2), Income

Tax Regs., or of Bowater, Inc. v. Commissioner, supra, which both

consider interest to be fungible for purposes of apportionment.

We, therefore, reject respondent’s argument and hold for

petitioners on this issue. Coca Cola Co. & Subs. v.

Commissioner, supra.

Accordingly, although in their returns with respect to CVI’s

taxable years in question, petitioners computed the commission

payable to CVI under the 50 percent of CTI method using gross

interest expense, they are entitled, pursuant to the authority of

Bowater, Inc. v. Commissioner, supra, to compute the commission
 - 51 -

using net interest expense for those years.

Stock Warrant Issue

The final issue that we consider is the character of the net

proceeds from the sale of the second warrant15 for the purchase

of stock in Sun.

Petitioners, contending that the second warrant was a

capital asset, argue that the entire amount of the proceeds from

the sale of the second warrant constitutes long-term capital

gain.

Respondent, contending that the second warrant constituted a

discount from the price of workstations purchased from Sun and

relying on section 1.471-3(b), Income Tax Regs., argues that the

entire amount of the net proceeds from the sale of the second

warrant constitutes either an increase in CV’s gross income or a

reduction in its cost of goods sold.

The transaction in issue is the same one that we considered

in Sun Microsystems, Inc. v. Commissioner, T.C. Memo. 1993-467,

where we decided the tax treatment of the first and second

warrants with respect to their grantor, Sun, except that in the

instant case we must decide the tax treatment of the second

warrant with respect to its recipient.

We conclude that the approach we took in resolving the issue

15

We note that only the tax treatment of the second warrant,
which CV sold on Mar. 12, 1987, is in issue in the instant case.
 - 52 -

in Sun Microsystems, Inc. v. Commissioner, supra, that is,

considering all the facts and circumstances of the transaction

between Sun and CV, is also appropriate in resolving the issue

presented in the instant case.16

We note initially that an allowance otherwise constituting a

trade discount should not be treated differently for tax purposes

simply because it takes the form of property that may ordinarily

16

Petitioners have objected, solely on grounds of relevance,
to the admission of certain stipulations and exhibits concerning
the transaction between Sun and CV that occasioned CV’s
acquisition of the second warrant. Petitioners, however, rely on
certain of the stipulations and exhibits in their proposed
findings of fact, and we deem petitioners to have conceded that
those stipulations and exhibits are relevant to the instant case.
We consider the remainder of the stipulations and exhibits
relevant to the instant case because our decision as to whether
the second warrant constitutes a trade discount or a capital
asset must be based on all the facts and circumstances concerning
the second warrant. Fed. R. Evid. 401. Moreover, even if the
stipulations and exhibits do not bear directly on the matters in
dispute herein, we find the stipulations to be admissible as
background evidence aiding our understanding of those matters,
and concerning which we have wide discretion in admitting.
United States v. Blackwell, 853 F.2d 86, 88 (2d Cir. 1988);
United States v. Daly, 842 F.2d 1380, 1388 (2d Cir. 1988).
Respondent objects to petitioner’s offer of respondent’s
trial memorandum submitted in Sun Microsystems, Inc. v.
Commissioner, T.C. Memo. 1993-467, on the grounds that it is
irrelevant to the instant case. However, for the same reasons
that we admitted the stipulations and exhibits referred to above,
we admit the trial memorandum.
Respondent also objects to petitioners’ offer of an expert
report submitted by respondent in Sun Microsystems, Inc. v.
Commissioner, supra, on the grounds that the report is
irrelevant, hearsay, and constitutes opinion evidence offered
without compliance with Rule 143. We declined to admit the
report into evidence in Sun Microsystems, Inc. v. Commissioner,
supra, because we found it, inter alia, argumentative and
irrelevant, and we decline to admit it in the instant case.
 - 53 -

be considered a capital asset. Consequently, our inquiry will

focus on whether or not the stock warrant in issue constituted a

trade discount given CV by Sun for the purchase of

workstations.17

Consideration of the facts and circumstances surrounding the

transaction between Sun and CV concerning the granting of the

second warrant leads us to conclude that the second warrant

constituted a trade discount from Sun to CV related to the

purchase of workstations. Respondent presented the testimony of

James Berrett, who was CV’s president at the time of the

negotiation of the agreements for the purchase of the

workstations and the issuance of the warrants. He testified

that, although the warrants were not a significant component of

the agreements between CV and Sun, they were an incentive for the

17

Petitioners contend that respondent abandoned on brief the
argument originally advanced in respondent’s trial memorandum
that the warrants in issue were within the inventory exception to
the definition of capital asset, sec. 1221(1), and suggest that
respondent is raising a new theory on brief by arguing that the
stock warrants constituted a trade discount. We consider
respondent’s argument on brief, however, to be merely a
development of the determination in the notice of deficiency,
which was that the net proceeds from the sale of the Sun warrants
were taxable “as ordinary income or as a decrease to cost of
goods sold.” We also disagree with petitioners that respondent
has conceded that a portion of the amount realized on the sale of
the warrants is taxable as long-term capital gain. Respondent
merely stated on brief, that, in the event we decided that the
appropriate time for recognition of the trade discount afforded
by the warrants was the date on which the warrants were first
exercisable, respondent would concede that the excess of the sale
price over their value on that date was gain from the sale or
exchange of a capital asset.
 - 54 -

purchase of workstations from Sun by CV and served to lower the

overall cost to CV of the transaction with Sun. Moreover, he

testified that CV had never invested in a supplier prior to the

transaction with Sun, did not make such investments, and did not

regard the warrants as an investment in Sun. Other witnesses

testified similarly. CV, in fact, never acquired any Sun stock

pursuant to the warrants, but sold the warrants shortly after

they first became exercisable to underwriters.

Additionally, the fact that the second warrant was

exercisable only upon the transaction of a specified dollar

volume of business between CV and Sun, either in the form of

purchases of Sun products or payment of royalties by CV,

indicates that it was in the nature of a trade discount.18 Other

circumstances connected with the transaction support such

characterization. The investment agreement made between Sun and

CV described the warrants as “an additional incentive for an

ongoing business relationship” between them. The transaction

with Sun involved a major strategic shift for CV from

manufacturing workstations to purchasing them from a vendor, and

the warrants operated as an additional incentive for CV to

18

A trade discount is generally considered a price reduction
that is allowed upon the purchase of a specified quantity of
merchandise. See Benner Tea Co. v. Iowa State Tax Commn., 109
N.W.2d 39, 43 (Iowa 1961); Argonaut Ins. Co. v. ABC Steel Prod.
Co., 582 S.W.2d 883, 887-888 (Tex. Civ. App. 1979); Sperry &
Huchinson Co. v. Margetts, 96 A.2d 706, 713 (N.J. Super. Ct. Ch.
Div. 1953), affd. 104 A.2d 310 (N.J. 1954).
 - 55 -

purchase the workstations from Sun rather than manufacturing them

itself, as did the reverse royalty arrangement with Sun. Under

the terms of the purchase agreement, CV would reach the dollar

volumes of business with Sun at which the second warrant would

become exercisable more rapidly if it purchased workstations from

Sun rather than manufactured them itself. If Sun became

successful by virtue of CV’s purchasing workstations manufactured

by Sun, Sun’s value would be enhanced, and CV could benefit from

the increased value through the exercise of the warrants. The

warrants CV received from Sun were intended to, and did in fact,

lower the cost to CV of purchasing workstations from Sun.19

Additionally, in their 1987 income tax return, petitioners

treated the net proceeds of the sale of the second warrant as a

reduction of cost of goods sold to the extent of the proceeds

that would have been realized on the sale of the second warrant

had it been disposed of when it first became exercisable

19

Petitioners, in an effort to bolster their argument that the
second warrant was a capital asset of CV, suggest that the
warrant represented “partial compensation to Computervision for
the below-market interest rate on the loans” CV made to Sun as
part of the workstation purchase transaction. If in fact the net
proceeds of the sale of the second warrant constituted additional
interest income to CV with respect to its loan to Sun, the
proceeds would be taxable as ordinary income and not long-term
capital gain. See Comtel Corp. v. Commissioner, 376 F.2d 791,
796-797 (2d Cir. 1967), affg. 45 T.C. 294 (1965); Green v.
Commissioner, 367 F.2d 823, 825 (7th Cir. 1966), affg. T.C. Memo.
1965-272. Accordingly, accepting petitioners’ suggestion would
not cause us to adopt petitioners’ characterization of the second
warrant as a capital asset.
 - 56 -

($1,823,172). Petitioners treated the remainder of the net

proceeds ($1,179,578) of the sale of the second warrant as long-

term capital gain. Moreover, CV described the second warrant in

its Forms 10-Q for the quarters ended March 31 and June 30, 1987,

as having been received “in conjunction with * * * a volume

purchase agreement” and treated a portion the net proceeds of the

sale of the warrant as a “volume purchase rebate”. Petitioners’

treatment of the second warrant for tax and financial reporting

purposes indicates that the warrant was in the nature of a trade

or volume purchase discount.20

Consequently, based on our consideration of all the facts

and circumstances in the instant case, we find that the second

warrant represented a trade discount received by CV from Sun in

the amount respondent determined is includible in petitioners’

income; i.e., the net proceeds realized by CV from its sale.21

20

The fact that only a portion of the net sale proceeds was
treated as a volume purchase discount merely indicates that CV
took the position that the amount of the discount was to be
determined at the time that the second warrant first became
exercisable and does not affect the admission as to its
character. As discussed below, we need not address the
appropriate time for measuring the amount of that discount.
21

Respondent contends that the full amount of the net proceeds
of the sale constitutes a trade discount, but notes that
petitioners may argue that the appropriate time for measurement
of the amount of discount is the time at which the second warrant
first became exercisable, which is the position petitioners took
in their return for 1987. Respondent further concedes that, in
the event we decide that the appropriate date for recognition of
the amount of the discount is the date used in petitioners’
(continued...)
 - 57 -

Having decided that the second warrant constituted a trade

discount, we next consider how the discount is to be taken into

account in computing petitioners’ taxable income. As a general

matter for tax purposes, where a trade discount is obtained with

respect to goods the cost of which has been included in a

taxpayer’s cost of goods sold, the discount is treated as an item

of gross income. If, however, the discount relates to goods the

cost of which is still in a taxpayer’s inventory, the cost of the

goods is reduced by the amount of the discount. See Turtle Wax,

Inc. v. Commissioner, 43 T.C. 460, 466 (1965). The parties have

not addressed whether, in the event we decide that the second

warrant constitutes a trade discount, the discount should be

treated as a reduction in the cost of goods in CV’s inventory or

as an item of gross income. In their return for 1987,

petitioners treated a portion of the net proceeds of the sale of

the second warrant as a reduction of CV’s cost of goods sold,

21
(...continued)
return, the treatment of the net sale proceeds in petitioners’
return was correct. Petitioners, on brief, contend that the full
amount of the net proceeds of the sale of the second warrant is
long-term capital gain and that the appropriate time for
recognition is the time at which the second warrant was sold.
Petitioners do not attempt to sustain their return position in
that regard, and we treat petitioners as not disputing
respondent’s determination of the appropriate time for
recognition of the discount attributable to the second warrant.
We note that we have recently ruled that the amount of a seller’s
deduction for a trade discount attributable to the grant of a
stock warrant is to be determined as of the time the warrant is
exercised. Convergent Technologies, Inc. v. Commissioner, T.C.
Memo. 1995-320.
 - 58 -

rather than as an item of gross income. Petitioners have not

argued that, in the event we decide that the second warrant

represented a trade discount, that treatment is incorrect.

Respondent also does not dispute that treatment, arguing simply

that the net proceeds of the sale of the second warrant

constitutes either ordinary income to CV or a reduction in its

cost of goods sold. We, therefore, hold that the entire amount

of the net proceeds of sale of the second warrant is a reduction

in CV’s cost of goods sold.

To reflect concessions and the foregoing,

Decisions will be entered

under Rule 155.