Young & Rubicam, Inc. v. United States

Delivered the opinion of the court.

These two cases, consolidated for trial, involve claims for refund of Federal income taxes for the years 1959 and 1960. There are common questions of fact and law.

Plaintiff, Young & Bubicam, Inc., claims a refund of an alleged overpayment of tax for the year 1959 caused by the disallowance of deductions for compensation and related business expenses. Similarly, it claims a refund of an alleged overpayment for the year 1960 caused by the disallowance of compensation and related expenses and also by the Commissioner of Internal Revenue’s determination that additional taxable income was allocable to plaintiff from the gross income of its foreign subsidiaries (as compensation to plaintiff for the management and administrative services it allegedly performed for these subsidiaries).

Two separate problems are presented. Firstly, may plaintiff deduct salaries and other related compensation paid to personnel assigned (on a full-time basis, with residence abroad) to positions with plaintiff’s foreign subsidiary corporations (generally for temporary periods of time ranging from six months to two years) as its own section 162 expense, or are these salaries expenses of the foreign subsidiaries ? Both tax years involve this issue. Secondly, has plaintiff proved that the Commissioner acted arbitrarily and capriciously by incorrectly allocating additional income to the taxpayer ? This question relates only to the year 1960.

The precise facts proved are determinative and we summarize the detailed facts presented in our findings, as follows:

Plaintiff is engaged in the advertising business. It commenced its operations in 1923 in Philadelphia, Pennsylvania. It enjoyed immediate success and within a short time moved its offices to New York City, in order to be closer to its major clients. With its principal office in New York City, branch offices were opened by plaintiff in Chicago, Detroit, Los Angeles, Hollywood and San Francisco, as its business volume increased. In terms of the dollar volume of gross billings, it is now the third largest advertising firm in the United States. Its clients include many large United States corporations.

In 1934, at the urging of plaintiff’s United States clients who were marketing their products in Canada (through Canadian subsidiaries), plaintiff organized a Canadian subsidiary corporation with offices in Montreal. Thereafter, the principal office of this subsidiary was transferred to Toronto.

With the end of World War II came a major expansion of marketing by United States firms into foreign countries. This was carried out directly and through subsidiary firms. United States advertising firms likewise opened offices abroad to provide advertising services for United States firms and their subsidiaries. The plaintiff, in line with this trend, also opened several offices abroad.

As early as 1944, one of the most important of plaintiff’s clients asked it to open a London office in order to assist in carrying out an advertising program for products which a foreign subsidiary was marketing and for other products that it expected to sell. Plaintiff formed a British subsidiary corporation under the name of Young & Kubicam, Ltd., with offices in London. In 1960, 'the plaintiff owned 62.6 percent of the stock of this corporation. The remainder of the stock of this subsidiary corporation was owned by employees of the British corporation. Plaintiff believed that if it did not enter the London advertising market, competitors would move in and take over the London advertising of its domestic clients and possibly thereby acquire the domestic advertising account of these clients.

In 1945, plaintiff opened an office in Mexico City, Mexico by forming a new subsidiary, Young & Eubicam, Mexico, S.A. In 1960, plaintiff owned 96.6 percent of the stock of this corporation. Plaintiff entered this market to keep pace with the expanding international marketing activities of its domestic clients and their foreign subsidiaries and, in addition, to expand its own organization into a world-wide advertising firm. There was no specific request from a client to enter this market, as had been the case in the London market.

In 1955, the plaintiff acquired an advertising agency in Puerto Eico. It thereafter organized a corporation — Young & Eubicam (Puerto Eico)' Corp. — and continued this operation under that name. In 1960, plaintiff owned 100 percent of the stock of this corporation.

In 1957, the plaintiff opened a branch office at Caracas, Venezuela. This office continued as a division of the plaintiff company until 1960, when a wholly-owned Venezuelan corporation was formed to conduct this business.

In 1955, the British subsidiary organized a subsidiary in Frankfurt, Germany. In 1959, a Swiss subsidiary was organized by the British corporation — this was known as Young & Eubicam, S.A. (Geneva). It provided only marketing studies or services for plaintiff’s United States clients and had only three employees. Both the German and the Swiss subsidiary corporations were wholly-owned by the British .corporation. Plaintiff has not shown that specific clients requested it to open any of the above offices.

As noted above, Young & Eubicam, Ltd. (Toronto) was formed in 1984. During 1960, 79.5 percent of its stock was owned by Young & Eubicam, Inc.

During the year-1960, plaintiff’s ownership or control of the aforementioned foreign subsidiaries may be summarized as follows:

Company Percent Owned by

Young & Eubicam, Lid. (London). 62.6 plaintiff

Young & Eubicam, G.m.b.H. (Frankfurt). 100.0 Y& E, Ltd. (London)

Young & Eubicam, S.A. (Geneva). 100.0 Y & E, Ltd. (London)

Young & Eubicam, Ltd. (Toronto).. 79.5 plaintiff

Young & Eubicam, Mexico, S.A. (Mexico City). 96.6 plaintiff

Young & Eubicam (Puerto Eico) Corp. (San Juan). 100.0 plaintiff

Young & Eubicam de Venezuela, S.A. (Caracas). 100.0 plaintiff

In 1959 and 1960 each of the corporations (except Young & Rubicam, S.A. of Geneva) operated a fully staffed advertising agency with a complement of employees in each of its principal operating departments: executive, accounting, art, copy, contact, marketing, media, production, research, traffic, television, etc. Each subsidiary had the facilities for and capability of performing every phase of its own advertising business. The number of employees on the payroll of each subsidiary during 1960 was as follows:

Subsidiary Employees

Young & Rubicam, Ltd. (London). 322

Young & Rubicam G.m.b.H. (Frankfurt). 69

Young & Rubicam, S.A. (Geneva). 3

Young & Rubicam, Ltd. (Toronto & Montreal). 177

Young & Rubicam, Mexico, S.A. (Mexico City)__.„. 41

Young & Rubicam (Puerto Rico) Corp. (San Juan). 38

Young & Rubicam de Venezuela, S.A. (Caracas). 49

Plaintiff maintained close supervision over the operations and finances of its subsidiaries. Periodic visits to the subsidiaries were made by plaintiff’s financial and accounting officers in carrying out this supervision. They did not assist the subsidiaries nor was assistance needed, since each subsidiary had its own accounting and financial staff.

Certain employees were sent abroad for extended periods to assist the subsidiaries. While abroad, they were paid all or part of their compensation by the plaintiff, together with travel expenses, moving and living costs and related entertainment and other expenses.

In the audit of plaintiff’s 1959 return, the Internal Revenue Service disallowed deductions for these amounts paid to personnel who were employed in foreign countries. Additional tax was assessed against plaintiff, paid by it and was the subject of a timely claim for refund. The amounts are shown in detail in finding 53.

The audit resulted in the disallowance of the deductions for salaries and expenses of some but not all of the individuals now involved in the section 162 deduction issue. (By its amended answer, the government has raised a set-off issue as to the deductibility of the remainder of the 21 individuals whose salaries and expenses for 1959 are in question.)

In the audit of plaintiff’s 1960 return, the Commissioner again disallowed the section 162 deductions for salaries and expenses and, in 'addition, be concluded that pursuant to section 482, $124,789 should be allocated to plaintiff as additional income from its subsidiaries for services rendered by-plaintiff.

The 90-day letter to plaintiff explained this allocation as follows:

(■b) It has been determined that you realized additional taxable income in the amount of $124,789.00 which has been allocated to you from the gross income of various of your controlled foreign subsidiaries for management and administrative services performed for them. * * *

It also explained that $325,754.86 was disallowed under section 162 “inasmuch as you [plaintiff] have not established same as allowable under any of the sections of the Internal Revenue Code.” The disallowance of these items (together with other disallowances not here in issue) resulted in the assessment of a deficiency for 1960 which was paid and for which a timely claim for refund was filed.

Both claims for refund were denied by the Commissioner. It was admitted by the defendant at trial, however, that an item of $6,070.85 (relating to the cost of an annual Christmas party for its employees) disallowed in the 1959 return is properly allowable. A concession was likewise made during the trial, that the $25,000 accrued for contributions to a scholarship fund in that year was properly deductible.

In addition, the defendant (at trial) conceded that the $40,000 compensation paid to Wilkerson ($13,000 for the period January 1, 1960 through April 19, 1960 and $27,000 for the period April 20, 1960 through December 31, 1960) was properly deductible and, therefore, should not have been disallowed. The defendant further conceded that as to entertainment, travel and a few small miscellaneous payments made to seven other employees, such payments were properly deductible as ordinary business expenses and should have been allowed as deductions in 1960 by the Commissioner.

The trial commissioner found that plaintiff had not offered any proof as to non-employee payments totaling $4,276.84. We adopt that conclusion.

We find that plaintiff is entitled to deduct some of its claimed section 162 expenses and that it should recover a refund of the deficiency assessed on the basis of the section 482 allocation

I. Section 162

Our concern is whether plaintiff or one of its subsidiary corporations, in substance, has actually received the benefit of (and therefore incurred and may deduct) a particular expense. Business expenses which satisfy the ordinary and necessary expense requirements of section 162 are deductible if they are “proximately connected to the business of the taxpayer claiming deduction therefor * * Eustice, Tax Problems Arising From Transactions Between Aflliated or Controlled Corporations, 23 tax l. key. 451, 475. Clearly, expenses incurred for the benefit of another taxpayer cannot be deducted under section 162. See, e.g., Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943); Deputy v. duPont, 308 U.S. 488 (1940). Under unique circumstances, to be discussed below, a section 162 deduction may be allowable if, for its own benefit, a taxpayer pays the expense of another.

The Commissioner of Internal Revenue has challenged plaintiff’s deductions for salaries, bonuses, profit-sharing and group insurance payments, travel and entertainment expenses, moving expense reimbursements and living expenses (a form of additional compensation) paid to 19 enumerated individuals. Plaintiff argues that these men were its employees and that their efforts while stationed abroad were for its direct and proximate benefit. Alternatively, plaintiff contends that even if their activities directly benefitted the foreign subsidiaries, plaintiff may deduct these expenses as its ordinary and necessary section 162 expenses because they were incurred with the underlying, motivating purpose of protecting and promoting its domestic advertising business.

A. Compensation and related payments

Plaintiff, Young & Eubicam, Inc., is in the business of representing advertisers in United States media. In addition, its International Division prepares special advertising materials for use in the media of countries where it does not have a subsidiary capable of preparing the material.

Each subsidiary corporation has its own trade or business, i.e., preparing advertising copy for use in the media of the foreign country where it is located. Certain major companies might employ both Young & Rubicana, Inc. as their U.S. representative and one or more of plaintiff’s subsidiary corporations as their representative for a particular foreign market; or an advertiser might be a subsidiary corporation’s client, but not a client of Young & Rubicam, Inc.

Plaintiff’s right to recover a refund turns on questions of fact. Under its first argument, plaintiff must prove that the specific services performed by each of the employees involved were for its direct and proximate benefit. The general and indirect benefit which obviously inures to a parent corporation when one of its subsidiaries successfully performs its functions does not satisfy the requirements of section 162.

In refund litigation, the taxpayer has the burden of proof because he is the plaintiff and because the government benefits from the presumptive correctness of the Commissioner’s administrative determination. See, e.g., United States v. Anderson, 269 U.S. 422 (1926) ; United States v. Mitehell, 211 U.S. 9 (1926) ; Welch v. Helvering, 290 U.S. 111 (1933); Oliver v. Commissioner, 364 F. 2d 575 (8th Cir. 1966); Parmelee Transportation Co. v. United States, 173 Ct. Cl. 139, 351 F. 2d 619 (1965); Forbes v. Hassett, 124 F. 2d 925 (1st Cir. 1942); First Trust & Deposit Co. v. Shaughnessy, 134 F. 2d 940 (2d Cir. 1943) ; cert. denied, 320 U.S. 744. In general, the taxpayer must prove the nature and details of the expenditures made to obtain a deduction. The issues must be decided upon the basis of the circumstances proved in each case.

The decision in Columbian Rope Company, 42 T.C. 800 (1964) Acq. 1965-1 C.B. p. 4 (as to other issues), provides some guidance. The Tax Court approved the parent corporation’s deduction for salaries paid to its executives who supervised and controlled its.subsidiary operations, as ordinary and necessary section 162 expenses. The salaries of those executives wbo were beld to be employed by tbe foreign. (subsidiary) corporation were beld non-deductible 'by tbe parent. Tbe court said:

We believe tbe record clearly shows that petitioner undertook these payments simply to aid its wholly owned foreign subsidiary to obtain the services of needed management personnel. A successful operation of tbe foreign subsidiary, through tbe services of such personnel, would obviously inure to tbe benefit of tbe petitioner as parent corporation. Petitioner’s willingness to undertake this obligation is understandable. But we do not believe that these dollar payments of salaries and related payments can be construed as petitioner’s own business expense * * *. [42 T.C. 815-816; emphasis ■added.]

Plaintiff cannot claim as its own expense, compensation paid for activities that were concerned with the day-to-day operation of tbe subsidiary corporation’s business. Any benefit to plaintiff from these activities cannot be considered proximate and direct to its own business and, therefore, these expenses are not allowable deductions under section 162.

It is to the proof of each individual’s activities, as presented by tbe record, that we now turn. We have concluded that some of tbe individuals performed no activities 'that directly benefitted plaintiff (in which case the deduction has been disallowed), that none of the employees perf ormed services exclusively for plaintiff’s benefit, and that many employees performed specific, but different, services both for a subsidiary and plaintiff. A deduction is allowable insofar as plaintiff has proved that a particular individual was involved in a specific activity clearly for plaintiff’s proximate and direct benefit; e.g., plaintiff’s foreign expansion program, marketing surveys and advice for plaintiff’s clients who planned to enter foreign markets (other than the specific market covered by the subsidiary wherein the individual was employed, because in that situation he would- have been soliciting additional business for the subsidiary corporation), or perhaps attempting to convince a particular client of the subsidiary to employ Young & Bubicam, Inc. as its U.S. representative. Where plaintiff has proved, in detailed rather than general terms, that an individual was involved in this kind of activity, a deduction for the compensation paid for these activities is allowable.

In addition, we have rejected plaintiff’s alternative argument. Our discussion summarizes the facts established by the record.

Plaintiff paid all of the compensation of certain individuals who were involved in the performance of the day-to-day operations of a subsidiary. It cannot deduct the entire compensation and fringe benefits paid for these services. Our problem is that some of these and other individuals (who received only part of their compensation from plaintiff) devoted some part of their total working time to activities which directly benefitted plaintiff. We start our analysis of this record with the premise that unless plaintiff has proved that an individual performed specific activities for plaintiff, it cannot deduct his compensation as its expense.

The employees divide into two groups: In the first group are Messrs. Austin, Brandi, Miller, Hoyt, DeVos, Zerbe, Hardy, Nussbaum, Gaudier and Lyon. The proof does not reveal specific activities performed by these men directly for plaintiff’s benefit and, therefore, plaintiff is not entitled to deduct any part of their salary as its own expense.

The second group contains the remainder of the 21 individuals. Their activities justify some deduction. In those cases where plaintiff paid all of the salaries earned, part of their total salary may be deductible, and an allocation will be necessary, perhaps on the basis of the amount of time devoted to specific activities on behalf of plaintiff or any other appropriate basis for a reasonable allocation. It consists of Messrs. Martinez, Vaamonde, Gearon, Waldron, Eeynolds, Olm-stead,. Schmitt, Lacey, Brody, Casey and Buckingham.

Plaintiff paid the entire salaries of Martinez, Vaamonde, Gearon and, in 1959, also Casey.

Martinez, whose activities we only summarize, was managing director of the Caracas office. Primarily he was responsible for the supervision of the Caracas office, its staff and department supervisors. Any compensation for these activities (directly beneficial to the subsidiary) is not deductible. There is proof, however, that he performed specific activities for plaintiff wholly apart from the business activities in Caracas. For example, he made several trips to investigate the possibilities of expansion into Brazil, Argentina, Colombia and Central America; he was involved in the acquisition of the Noble Agency and in the possible expansion into the Caribbean area. Compensation for these activities is deductible.

During 1960, Martinez was transferred to Mexico. There is scant proof in the record that he thereafter devoted himself to any activity other than the day-to-day operation of the Mexican subsidiary corporation.

Vaamonde presents a comparable problem. He was the manager of the Mexican subsidiary and responsible for its successful operation, i.e., developing talent, making client contacts, etc. Mr. Vaamonde estimated that some 60 to 70 percent of his time was devoted to activities similar to those performed by Martinez. On the basis of this record, some, but not all, of the deduction for his compensation is appropriate.

Gearon was head of contact services in the London office and was involved in solving the problems of clients of Young & Eubicam, Ltd. There is proof, albeit in some instances indefinite, that he devoted some part of his time to servicing the particular needs, other than in England, of clients of Young & Eubicam, Inc. who were not clients of the British corporation. On January 1,1960, he was assigned to the German office where he was responsible for its day-to-day operar tions. Certain other activities were undeniably for-plaintiff’s benefit. He investigated the possibility of expansion into Italy and France, for example. Compensation for time devoted to promoting the advertising business of the German subsidiary among plaintiff’s domestic clients, however, is not deductible by plaintiff. Again, we conclude that some but not all of his compensation is deductible.

Casey was sent to England for the express purpose of correcting a problem that involved Procter & Gamble’s advertising in England. Plaintiff believed that dissatisfaction with the advertising in England might have led Procter & Gamble to sever its ties with plaintiff and, therefore, Casey was sent to correct the problem and preclude this possibility. It is clear that his efforts directly benefitted the British subsidiary because it was able to retain Procter & Gamble as a client. The residual benefit to plaintiff does not suffice for its claimed deduction.

Any time that Casey devoted to studies for possible expansion into European markets, the preparation of reports and travel in Europe for the purpose of expanding clients’ activities in markets other than England were for plaintiff’s benefit and compensation therefor is deductible. There is testimony that he spent approximately one-half of his time on problems for plaintiff. If justified by the record, this would appear to be an appropriate basis for allocating his salary between activities for the subsidiary and activities for plaintiff.

Messrs. Brody, Buckingham, Lacey, Schmitt and, in 1960, also Casey, form another subgroup. Plaintiff paid more than 50 percent of each man’s salary. The proof presented as to their activities indicates that each devoted a substantial amount of time to specific activities for plaintiff’s benefit. Therefore, all of the compensation paid to Brody, Casey and Buckingham is deductible, and some part of that paid to Schmitt and Lacey is deductible.

Brody shared the day-to-day operational duties in the German office with Gearon. In addition, he investigated possibilities for expansion into Austria, Switzerland and France. He investigated and reported on markets in other countries for clients of plaintiff. His activities for plaintiff increased substantially after March of 1960. We find the testimony adequate to establish the details of his activities for plaintiff and find that all of the compensation paid to him is deductible.

Buckingham performed numerous services for plaintiff including trips on plaintiff’s behalf to investigate new markets and report on companies which plaintiff might acquire. In addition, he reported to plaintiff on the activities of various subsidiaries. We think that plaintiff has carried its burden of proof as to Buckingham.

Schmitt and Lacey were sent to Germany for the purpose of building a staff of writers and artists. Their activities were primarily devoted to the German market and its problems. There is some testimony that they were involved in the plans for European expansion but the extent of their participation does not appear from the record to justify the salary deduction taken by plaintiff. We conclude, therefore, that, some part of the deduction is allowable and here, too, an allocation would seem appropriate.

. The final subgroup consists of Messrs. Eeynolds, Waldron and Olmstead. (Plaintiff paid less than 50 percent of their salaries.) Each performed specific services for plaintiff. Eey-nolds was involved in studies for European expansion and developing plaintiff’s continental operation and, in addition, he devoted part of his time to obtaining new clients for plaintiff’s domestic business. Waldron was involved in similar activities, albeit on a lesser scale. Olmstead was primarily involved in the business activities of the office in Mexico but the record indicates that he was also involved in specific activities directed toward obtaining clients for plaintiff.

■ In summary, on the basis of a thorough study of the entire record, we disallow the deductions for Messrs.'Austin, Brandi, Miller, Hoyt, DeVos, Zerbe, Hardy, Nussbaum, Gaudier,and Lyon; We allow a deduction as claimed for Messrs. Brody, Buckingham, Eeynolds, Waldron, Casey (1960) and Olmstead. We also allow a partial deduction for Messrs. Vaamonde, Martinez, Gearon, Lacey, Schmitt and for 1959, also Casey (the exact amount of which will be determined by our trial commissioner).

B. Travel, entertainment and moving expense reimbursement

The Memorandum re Pretrial Conference records in minute detail the precise amounts paid to specific individuals for travel and entertainment expenses. However, there is a dearth of additional information in the record about each activity’s relationship either to a subsidiary’s or plaintiff’s business.

Certain deductions have been conceded by defendant. Plaintiff may deduct the remaining travel or entertainment expenses if it proves that the amount involved was paid for some definite and reasonable purpose connected with its business. Again, this is a question of fact. These expenses have been itemized with admirable care. The only remaining problem is “tieing” the expense item to a specific activity.

We return this case to the trial commissioner for a determination of the amount of travel and entertainment expenses deductible as plaintiff's expense. In the absence of adequate proof, plaintiff is not entitled to a deduction.

There is one other problem which has not been briefed by either plaintiff or defendant; i.e., the deductibility of moving expense reimbursements paid by plaintiff, a former employer, to employees who moved to a foreign country for the purpose of working for another independent corporate entity. We do not now decide this issue but expect that it will be briefed to and decided by our trial commissioner.

O. Plaintiff’s Second Contention

Plaintiff’s alternative argument is that even if the individuals’ activities were for the subsidiaries’ direct benefit, it may deduct the expenses because they were “motivated by a purpose to protect and promote the plaintiff’s own business and its relationship to its own customers.” It cites as support, Cubbedge Snow, 31 T.C. 585 (1958), Acq. 1959-1 C.B. 5; L. Heller and Son, Inc. 12 T.C. 1109 (1949); Robert Gaylord, Inc., 41 B.T.A. 1119 (1940); Dunn & McCarthy, Inc. v. Commissioner, 139 F. 2d 242 (2d Cir. 1943); and J ames L. Lohrhe, 48 T.C. 679 (1967), Acq. 1968-27 I.R.B. p. 7, in addition to the cases relied on by tire trial commissioner, Fall River Gas Appliance Co., Inc., 42 T.C. 850 (1964), aff'd, 349 F. 2d 515 (1st Cir. 1965); United States v. E. L. Bruce Co., Inc., 180 F. 2d 846 (6th. Cir. 1950) ; Scruggs-Vandervoort-Barney, Inc., 7 T.C. 779 (1946); Charles J. Dinardo, 22 T.C. 430 (1954); and Columbian Rope Co., supra.

In the unique factual circumstances of the above cases, courts have carved an exception to the general rule that a taxpayer cannot deduct amounts paid for expenses of another taxpayer. See Welch v. Helvering, supra. We do not find that the circumstances surrounding the deductions claimed by plaintiff are within the narrow exceptions espoused by these cases.

In Charles J. Dinardo, supra, taxpayers were doctors who had organized a non-profit hospital for their patients’ use. Amounts paid to the hospital when it incurred a current operating deficit, for the purpose of insuring its continued existence, were held deductible.

In Cubbedge Snow, supra, taxpayers were real estate attorneys who had organized a Federal savings and loan association to promote their title abstract law practice. They paid an operating deficit of the savings and loan association to insure their continued source of business.

In Heller and Son, Inc., supra, a corporate taxpayer paid the debts of its bankrupt subsidiary for the purpose of reestablishing its own lost credit rating (which was essential for its continued existence). Scruggs-Vandervoort-Barney, Inc., supra, involved a corporate taxpayer who paid depositors’ losses caused by the failure of a bank closely associated with plaintiff taxpayer (97 percent stock ownership). Amounts paid to preclude an imminent threat of lost business justified the expense as one made to protect plaintiff’s existing business.

In Dunn & McCarthy, Inc., supra, a corporate taxpayer repaid loans made by its seven top salesmen to its former president. In return, it received assignments of their claims against the president’s estate. Its existing business was dependent upon the activities of these men, and these amounts were therefore held deductible.

In James L. Lohrke, supra, an individual agreed to make good any losses caused by defective products that were sold by a corporation to which he had given a nonexclusive patent license. The amounts were paid to preserve the value of his patent-licensing business and were held deductible.

In Robert Gaylord, Inc., supra, taxpayer made payments pursuant to its guarantee given to a bank to insure the bank against any losses from its acquisition of another bank which was about to fail. The guarantee was given and payments were made to protect plaintiff against an immediate, substantial loss of business if the bank had failed; more immediate was the danger that it would have been unable to collect its own existing credit accounts.

All of these cases involved a clear proximate danger to the taxpayer and each involved a payment made to protect an existing business from harm. In our case, assuming that the claimed deductions by Young & Rubicam, Inc. were for the subsidiaries’ benefit, they were general operating expenses of a subsidiary and plaintiff has not proved that they were made either to prevent proximate harm or to protect plaintiff’s existing business from such harm.

It is true that plaintiff was encouraged to enter the field of international advertising by some of its domestic clients. Plaintiff claims that these amounts were deductible because it faced a possible loss of domestic business if the service given by its subsidiaries was inadequate. We are not convinced by the evidence before us that plaintiff was threatened with a direct and immediate loss of domestic business if its subsidiary did not perform the services requested by a client of both the subsidiary and plaintiff. (Of course, the subsidiary was likely to lose some business.) Moreover, the possibility of any loss of domestic business was remote from the payments made for salaries, compensation and other claimed expenses. The exception adopted by the above cases turns on a proximate danger or benefit and they generally do not involve payments by a parent corporation for the current operating costs of its subsidiary. Plaintiff paid these costs primarily to obtain better personnel for its subsidiaries and to improve their operations, and any benefit to it was indirect.

The only case cited which tends to give some support to the claim that these expenses were made to promote plaintiff’s domestic business is Fall River Gas Appliance Co., supra. In that case, a parent gas company paid the installation, selling and miscellaneous expenses of its subsidiary, a gas appliance company. The Tax Court found that the direct relationship between an increase in taxpayer’s gas sales and the number of appliances sold by the subsidiary was sufficient to allow the parent a deduction. The court noted that this was not the typical case of a parent company paying its subsidiaries’ expenses.

In our case, there is no comparable direct link between an increase in the subsidiary’s foreign advertising and the domestic advertising of plaintiff. This is the more typical instance of a parent corporation paying the expenses of its subsidiary. For the above reasons, we reject plaintiff’s alternative argument and allow recovery of a refund for both 1959 and 1960 only to the extent discussed above in parts A and B.

II. Section 182

The second question for determination is whether section 482 was properly invoked by the Commissioner of Internal Revenue for the year 1960. An affirmative answer would, in turn, lead our inquiry into a number of subsidiary questions, such as: whether proper notice regarding the allocation was given to the plaintiff and whether, in fact, an “allocation” was made. We note that the 90-day letter did not show how the subsidiaries were to be charged with income. Our determination of this issue, however, does not require resolution of these subsidiary questions.

Under section 482, the Commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among related taxpayers, when he determines that it is necessary to prevent the evasion of taxes by, or clearly to reflect income of, such taxpayers. The section was designed to prevent evasion of taxes by such devices as “shifting of profits, the making of fictitious sales and other methods frequently adopted for the purpose of ‘milking’.” H.R. Rep. No. 2,70th Cong., 1st Sess., p. 16; S. Rep. No. 960,70th Cong., 1st Sess., p. 24. Its purpose is to prevent the arbitrary shifting of income and deductions among controlled corporations and to place such corporations on a “tax parity” with uncontrolled corporations. Treas. Reg. Sec. 1.482.1.

Plaintiff has argued that the Commissioner improperly invoked section 482 because, inter alia, the action was unnecessary to prevent evasion of taxes or clearly to reflect income, the Commissioner failed to distribute, apportion or allocate income or deductions among related taxpayers, and the determination was arbitrary and produced an unreasonable result. The Commissioner charged plaintiff with having understated its income by the amount which the plaintiff failed to charge its subsidiaries for management and administrative services allegedly performed by the plaintiff for such subsidiaries. There is substantial confusion in the record as to the exact original basis of the Commissioner’s allocation. Before the trial commissioner, the government admitted that the allocation was not supported by the Revenue Agent’s theory (which formed the basis of the Commissioner’s allocation and deficiency assessment) but argued that the ultimate amount allocated is reasonable on the basis of the value of the management services performed by four of plaintiff’s employees — Wilkerson, Hagen, Penn and Hardy. Defendant argues that the Revenue Agent’s methods are therefore irrelevant and that the allocation was reasonable and supported by the record before the court. See, Oil Base, Inc. v. Commissioner, 362 F. 2d 212 (9th Cir. 1966), cert. denied, 385U.S. 928.

Generally, because the Commissioner is given wide discretion, the taxpayer not only has the burden of overcoming the presumptive correctness of the Commissioner’s action but also proving that his section 482 determination (or a determination based on a predecessor section) was arbitrary or capricious. See, National Securities Corp., 46 B.T.A. 562, 564 (1942), aff'd, 137 F. 2d 600 (3d Cir. 1943), cert. denied, 320 U.S. 794 (1943); G.U.R. Co. v. Commissioner, 117 F. 2d 187 (7th Cir. 1941); Aiken Drive-In Theatre Corp. v. United States, 281F. 2d 7 (4th Cir. 1960); and Leedy-Glover Realty & Insurance Company, 13 T.C. 95, 107 (1949), aff’d, 184 F. 2d 833 (5th Cir. 1950). If the Commissioner’s action is subjected to judicial review, the taxpayer bears the heavier than normal burden of proving arbitrariness (see, Campbell County State Bank, Inc. v. Commissioner, 311 F. 2d 374 (8th Cir. 1963)), and therefore it has been held that the Commissioner must give the taxpayer fair notice in advance of trial that he is acting pursuant to section 482 (see, Commissioner v. Chelsea Products Company, 197 F. 2d 620 (3rd Cir. 1952)), and if the Commissioner makes no mention of the section 482 issue in his deficiency notice, the Tax Court has expressed some doubts as to the government’s ability to raise this issue for the first time at trial (see, Chicago and North Western Railway Company, 29 T.C. 989 (1958)), or in its opening statement (see, Seminole Rock and Sand Co., 19 T.C. 259 (1952)), or on brief (Burrell Groves, Inc., 16 T.C. 1163 (1951) ; Palm Beach Aero Corp., 17 T.C. 1169 (1952)).

We can assume that plaintiff received adequate notice that a section 482 issue was involved in the deficiency assessed for 1960. We have before us, however, the unusual circumstance where the government has not argued that the Commissioner’s determination is justifiable on the basis of the calculations made by the Revenue Agent or other Internal Revenue Service personnel, but rather that wholly different reasons proved to the trial commissioner support the amount of the allocation.

The record facts which defendant argues support the allocation, we find do not. We conclude that the evidence does not justify the Commissioner’s allocation and that the specific transactions relied on by defendant are not subject to an allocation.

The Commissioner may allocate costs or deduction to properly reflect managerial, administrative or other services performed by one member of a group for another member. Allocation is an attempt to reflect the true income of related companies as if the services had been performed by an unrelated entity. See, Eli Lilly & Co. v. United States, 178 Ct. Cl. 666, 372 F. 2d 990 (1967); and Oil Base, Inc. v. Commissioner, 362 F. 2d 212 (9th Cir. 1966), cert. denied, 385 U.S. 928. The Commissioner allocated income to plaintiff to measure the value of the managerial services it purportedly performed for the subsidiaries through four individuals— Messrs. Wilkerson, Hagen, Penn and Hardy. Unlike the 21 individuals involved in section I of this opinion, they were not assigned to continuous duty abroad with a particular subsidiary, and we are not faced with the question of the deducti-bility of their salaries. The fact question is whether they performed general supervisory services for plaintiff or they performed managerial services for a subsidiary for which the subsidiary would have paid a fee had they been performed by an unrelated corporation. Our conclusion is that the activities proved were general supervision for plaintiff and that no support exists in this record for the allocation. Supervisory functions such as these are not subject to allocation under section 482.

Many of these activities benefited the subsidiaries, but we are concerned with whether the functions performed were supervisory controls for plaintiff or specific management services for a subsidiary. The nature of these activities, as reflected in the record and relied on by defendant, are summarized as follows:

Wilkerson was a senior vice-president of plaintiff and head of its International Division from January 1 through April 19, 1960. The International Division was responsible for the general supervision of subsidiary corporations and promoting additional foreign expansion. Wilkerson was directly responsible to plaintiff’s president and its Board of Directors.

In 1959, plaintiff received complaints that the Creative and Research Departments of its German office were not developing satisfactory material. General Foods had threatened to terminate its relationship with the German subsidiary. Wilkerson traveled to Frankfurt when Gaudier replaced Nussbaum as managing director and met with, representatives of the subsidiary’s clients. He had represented General Foods as plaintiff’s client and had substantial contacts with personnel in the General Foods headquarters in New York. He made several trips to Frankfurt, and eventually the problem was solved.

In January 1960 he went to Puerto Eico when Brandi replaced Austin as general manager and installed DeVos as assistant manager. Again he visited with some of the subsidiary’s clients. There is no indication that either his activities in Frankfurt or Puerto Eico were management services, rather they were an attempt to exert some “on-the-spot” supervision.

Lyon had been sent to Toronto to correct a particular problem with the Whitehall Laboratories Ltd. account and, in April 1960, Wilkerson traveled to Toronto to discuss the problem. He also made several trips to London.

During 1960 he made several new business presentations to companies interested in marketing their products internationally. One of his general functions as head of the International Division was to encourage companies to hire all of plaintiff’s subsidiaries as their representatives for particular markets.

On the basis of this record, we conclude that his activities were in the nature of supervisory controls or other general activities for plaintiff and not management services for the business of a particular subsidiary.

Hagen was a vice-president in charge of Western Hemisphere corporations. He reported to Wilkerson until April, 1960 and thereafter to the plaintiff’s president. His responsibility was to make certain that the various offices maintained plaintiff’s production standards and that the subsidiaries performed their duties to their clients’ satisfaction. He frequently traveled to the offices of a subsidiary’s clients to hear complaints and accept general comments on the activities of a particular subsidiary.

In 1960, plaintiff decided to consolidate its Montreal and Toronto offices and Hagen traveled to Toronto to solve any personnel problems that might arise in connection with the consolidation. He also made three trips to Mexico City to discuss general problems with Vaamonde and his replacement Martinez. He also made one trip to Caracas. Again, the record proves that these were general supervisory activities which assisted plaintiff in its attempt to control the activities of its subsidiaries.

Penn had been a partner in the Penn-Zerbe advertising agency which plaintiff acquired in 1956. He became a managing director of New York International Services and during 1960 traveled to San Juan together with Wilkerson when DeVos replaced Austin as managing director. He attended presentations by San Juan personnel to their clients. He made five trips to Caracas and met with Young & Pubicam de Venezuela’s clients together with personnel from the subsidiary. He also made one trip to Mexico City. There is no proof of the specific managerial services which defendant alleges he performed for the subsidiaries.

Hardy was an account executive assigned to New York International Services from February 16 to October 9. On May 16, he traveled to Caracas where he remained until June 20. He managed the office when Martinez traveled to the United States. Later in the year he went to Venezuela.

He also traveled to Mexico City together with representatives of clients to meet with Vaamonde and solved several problems that had developed. This was part of a general circuit trip to other parts of Central and South America. His activities were also supervisory.

We think that the above summary shows that the activities relied on by defendant to support the Commissioner’s allocation were part of plaintiffs attempt to control its subsidiaries, their personnel and offices. There is no evidence that these four individuals performed specific managerial services for specific subsidiaries, and therefore we must conclude that the allocation is not supported by the record and that the Commissioner’s allocation was improper. Plaintiff is entitled to recover a refund on this issue. Accordingly, judgment is entered for plaintiff, with the amount of recovery to be determined pursuant to Eule 47 (c).

BINDINGS OK FACT

The court, having considered the evidence, the report of Trial Commissioner William E. Pay, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff is a New York corporation engaged in the advertising business, having its principal office at 285 Madison Avenue, New York, New York. It brings these actions to recover federal income taxes assessed and collected from it by the District Director of Internal Eevenue for the Upper Manhattan District of New York for the calendar year 1959 in the sum of $35,796.14 and for the calendar year 1960 in the sum of $317,996.93. The jurisdiction of this court was invoked under section 1491 of title 28 of the United States Code, 62 Stat. 940.

2. On June 15,1960, plaintiff filed its 1959 income tax return with the said District Director and paid the taxes assessed thereon in the sum of $1,621,283.19. On December 19, 1961, following the audit of the said return, the plaintiff paid the said District Director a deficiency in income taxes asserted against it in the sum of $34,977.04, together with assessed interest thereon of $3,672.59.

3. Thereafter, on August 12, 1963, the plaintiff duly and timely filed a claim for refund of the said deficiency paid for the year 1959 plus assessed interest. This claim was based on plaintiff’s contention that amounts paid by it in 1959 for compensation, moving and living expenses, travel and other related expenses paid to or on behalf of its employees assigned to subsidiary offices in various foreign countries were deductible as its ordinary and necessary business expenses. In addition, plaintiff claimed that the amount of certain Christmas gifts to employees and a 1961 foreign tax credit carryback were also allowable as deductions in 1959.

4. On October 7,1964, the District Director disallowed the said 1959 claim for refund in its entirety. However, upon the trial herein, defendant conceded that the aforementioned Christmas gifts in the sum of $6,070.85 were allowable deductions. At the same time, plaintiff abandoned that portion of its 1959 and 1960 claims which related to the payment of compensation to Willi Heumann of Frankfurt, Germany.

5. On June 15,1961, plaintiff filed its 1960 income tax return with the said District Director and paid the taxes assessed thereon in the sum of $1,273,064.74. Following the audit of the said return the Commissioner of Internal Revenue (at times referred to as the “Commissioner”) issued a statutory notice of deficiency against the plaintiff for the year 1960 of $262,201.82. In the said notice of deficiency the following explanation was given of the two items which remain in issue:

(a) Expenses enumerated below incurred in behalf of various foreign affiliates and deducted on your return, have been disallowed inasmuch as you have not established same as allowable under any of the sections of the Internal Revenue Code.

Salaries and bonuses_$218,991.61

Profit-sharing contributions_ 23,219.40

Group insurance_ 1,791.41

Audit and legal- 1, 646. 52

Auto expense!--- 510.97

Business lunches_ 125.76

Dues and subscriptions- 326. 95

Entertainment_ 3,488.21

Fares- 102. 68

Miscellaneous _ 135.36

Moving and living expenses_ 47,127.91

Outside services_ 3,169. 04

Overtime meals-— 52.20

Postage and expressage- 929.33

Stationery and supplies- 948. 03

Telegraph and telephone_ 99.72

Travel_ 23,089.76

Total_$325,754.86

(b) It has 'been determined that you realized additional taxable income in the amount of $124,789.00 which has been allocated to you from the gross income of various of your controlled foreign subsidiaries for management and administrative services performed for them.

6. On October 13,1964, the plaintiff paid the said deficiency for 1960, together with assessed interest of $55,795.11, or a total of $317,996.93. On October 27, 1964, the plaintiff duly and timely filed a claim for refund of the said deficiency and assessed interest. This claim was based on plaintiff’s contention that expenses for compensation and other miscellaneous business expenditures in the aggregate amount of $325,754.86 paid to or on behalf of its employees assigned to subsidiary offices in various foreign countries were deductible as its ordinary and necessary business expenses and, also, that the Commissioner of Internal Eevenue had erroneously determined that $124,789 of additional income was allocable to it (under section 482 of the Internal Eevenue Code) from its foreign subsidiaries for management and administrative services performed for them. In addition, plaintiff claimed that the sum of $8,325.12 was erroneously allocated to it (under section 482 of the Internal Eevenue Code) from its Venezuelan subsidiary for interest charges and, further, that the said Commissioner had erroneously disallowed an accrual of $25,000 for contributions to the Young & Eubicam Foundation and the Young & Eubicam Scholarship Fund.

7. On February 17,1965, the District Director notified the plaintiff of the disallowance of its 1960 claim in full. However, upon the trial herein, defendant conceded that the plaintiff was entitled to a deduction for the aforementioned accrual for contributions in the sum of $25,000 and that it had not realized additional income of $8,325.12 from its Venezuelan subsidiary on account of constructive interest charges.

8. Plaintiff duly commenced the within actions to recover the taxes demanded in the refund claims rejected by the Commissioner of Internal Eevenue, and raised the same issues in these actions as it did in its said claims.

9. The plaintiff, Young & Eubicam, Inc., commenced business as an advertising agency in Philadelphia, Pennsylvania, upon its incorporation in 1923. Its business quietly prospered and within a short time, in order to achieve proximity to its major clients, it removed its offices to New York, New York. As its business within the United States grew, it opened branch offices in the cities of Chicago, Detroit, Los Angeles, Hollywood and San Francisco.

10. Some of plaintiff’s clients who were advertising and marketing their products in Canada had been unable to secure satisfactory advertising services in that country. In 1934, at the insistence of these clients, plaintiff organized a subsidiary corporation in Canada and opened its offices in Montreal. Later, the principal office of this subsidiary was transferred to Toronto.

11. Following the end of World War II a major expansion in international marketing and advertising occurred in Europe. The largest American advertisers of consumer products began their entry into this market at about this time. The domestic advertising agencies which represented these American companies, in order to maintain their standing and to build goodwill with their clients, found it expedient to open offices abroad and thereby provide advertising services for them in these foreign markets.

12. Plaintiff’s management also recognized the necessity for developing its own group of foreign advertising offices. It regarded such services to its United States clients in foreign countries as an opportunity to strengthen its relationships with them and, by the development of successful advertising campaigns for new products and other business abroad, to increase the scope of its services to them in the United States. At the same time, the plaintiff’s availability abroad could prevent other American agencies from acquiring the foreign advertising business of its United States clients, which might lead such competitors to other business from these clients in domestic markets.

13. In 1944, one of the plaintiff’s most important clients urged the plaintiff to open an office in Loudon to better advertise products which that client, through its foreign subsidiaries, was marketing, and other products which it expected to market in England. Accordingly, the plaintiff, in November 1944, formed a subsidiary agency in London, under tbe name Young & Eubicam, Ltd. In 1960 the plaintiff owned 62.6 percent of the stock of this subsidiary with the balance owned by active employees of such subsidiary company. In forming this subsidiary company, the plaintiff was well aware that if it was not prepared to handle the advertising of the subsidiaries of its domestic clients, its competitors would be glad to do so, and in so doing, would be placed in a position where they might take away from plaintiff some of its important domestic clients.

14. In 1945 Young & Eubicam, Inc. formed the first of its Latin American corporations — in Mexico City, Mexico. The company management was aware that the commencement of business there involved serious financial risks because of the prevailing political and financial instability of that area. Nevertheless, plaintiff entered this market because it was convinced of the necessity to keep pace with the international activities of its domestic clients and to provide them with advertising services wherever such clients desired them. However, no other Latin American office was opened by plaintiff for almost a decade thereafter.

15. In 1955 Young & Eubicam acquired a Puerto Eican agency doing business under the name of Zerbe-Penn. It subsequently organized a New York corporation — Young & Eu-bicam (Puerto Eico) Corp. — and continued the operation of this business under that name. In 1957 it opened an office in Caracas, Venezuela, which it operated as a division or branch office of the domestic company until January 1960, when a Venezuelan corporation was organized to conduct this business.

16. In 1955 Young & Eubican entered the European market in order to provide advertising services for its principal domestic clients which had commenced business on the continent. In that year, a German subsidiary of the London company was organized and an office was opened in Frankfurt, Germany. Later, in 1959, a Swiss subsidiary — Young & Eubicam, S.A. — was organized by the London company for the purpose of providing American clients with European marketing services. However, no advertising business was conducted by this subsidiary and it had a staff of only three employees.

17.During the year 1960 the ownership or control of the aforementioned foreign subsidiaries was as follows:

Company Percent Owned by

Young & Rubicam, Ltd. (London)__ Young & Rubicam G.m.b.H. (Frankfurt).. Young & Rubicam, S.A. (Geneva)__ Young & Rubicam, Ltd. (Toronto)... Young & Rubicam, Mexico, S.A. (Mexico City)_ Young & Rubicam (Puerto Rico) Corp. (San Juan) Young & Rubicam de Venezuela, S.A. (Caracas)_ 62.6 plaintiff 100.0 Y & R, Ltd. (London) 100.0 Y & R, Ltd. (London) 79.5 plaintiff 96.6 plaintiff 100.0 plaintiff 100.0 plaintiff

18.In 1959 and 1960 each of the subsidiaries (except Young & Rubicam, S.A. of Geneva) operated a fully staffed advertising agency with a complete complement of employees in every one of its principal operating departments: executive, accounting, art, copy, contact, marketing, media, production, research, traffic, television, etc. Each of these subsidiaries had the facilities and capability of performing every phase of its own advertising business by itself. The number of employees on the payroll of each subsidiary during 1960 was as follows:

Subsidiary Employees

Young & Rubicam, Ltd. (London)_ 322

Young & Rubicam G.m.b.H. (Frankfurt)_ 69

Young & Rutoicam, S.A. (Geneva)_ 3

Young & Rubicam, Ltd. (Toronto & Montreal)_ 177

Young & Rubicam, Mexico, S.A. (Mexico Oity)_ 41

Young & Rubicam, (¡Puerto Rico) Corp. (ISan Juan)_ 38

Young & Rubicam de Venezuela, S.A. (Caracas)_ 29

19.Sigurd Larmon was employed by Young & Rubicam, Inc. in 1929. He was made president of the company in 1942, and became chairman of the board of directors and chief executive officer in 1944. He held the latter position throughout the period here involved. He was chairman of the boards of directors of all of the subsidiary corporations and was the single most important individual responsible for the growth of Young & Rubicam, Inc. and of its foreign subsidiaries. George Gribbin was president of Young & Rubicam, Inc. and the chief operating officer in charge of its domestic affairs during 1959 and 1960.

20. Young & Rubicam, Inc. exercised careful supervision over the operations and finances of its subsidiaries. Under the accounting procedures and controls which it established, each of the subsidiaries was required to file monthly and annual operating statements and budgets. In addition, the financial and accounting officers of the parent company made periodic visits to the offices of the subsidiaries, to review their accounting practices, to verify the accuracy of their reports and to examine into their current financial conditions. However, each subsidiary had a complete accounting and financial staff which did not require or receive operating, financial or accounting assistance from the employees of the parent company.

21. Constant supervision of the subsidiaries was also maintained by the board chairman of the parent company, by its president, the head of its International Division and by others. These employees visited the subsidiary offices periodically to check on the calibre of advertising services being performed, to review agency relationships with international clients, and in general, to examine the operations of each subsidiary office for the purpose of reporting to plaintiff’s board of directors. None of the said employees performed any operational or current business functions for the subsidiaries in the course of these supervisory visits.

22. The plaintiff, Young & Rubicam, Inc., prepared and placed advertising for certain of its domestic clients in foreign countries where neither the client nor Young & Rubicam had a subsidiary corporation. These foreign advertising services were performed by a subdivision of its International Division known as New York International Services. During 1959 and the first half of 1960 the International Division was headed by James P. Wilkerson (also known as “Joe” Wilkerson) and during the second half of 1960, by Ward Hagen. The entire staff of this subdivision consisted of approximately 29 employees. The advertising placed abroad was usually prepared by Young & Rubicam in the United States, translated into whatever foreign language was necessary, and then sent to the foreign country for placement through an independent and unrelated foreign associate agency.

23. A second function of the International Division was to supervise the business activities of the various foreign subsidiaries for the purpose of reporting to the board of directors and top management of Young & Eubicam, Inc. During 1959 and 1960, James Wilkerson, a member of this division, supervised the European subsidiaries, while Ward Hagen and his assistant, Eichard Pemi, supervised the Western Hemisphere subsidiaries.

24. In 1959, plaintiff’s management decided to intensify its efforts to expand its foreign operations because of its lack of progress in the international field to that time. Some of its foreign subsidiaries were performing poorly and it became apparent that the company’s entire foreign program would have to be strengthened if the plaintiff was to survive as an important worldwide advertising agency. The failure of its international program would have had a serious effect upon the plaintiff’s entire business.

25. James P. Wilkerson has been employed continuously by Young & Eubicam, Inc. from 1934 to the present date. In 1959, he became a senior vice president and the director of the International Division. His primary responsibility was the supervision of foreign subsidiaries and their managing directors. In the spring of 1960, Larmon advised Wilkerson that he was to be transferred abroad and would become the managing director of the British subsidiary. Wilkerson was told he would retain his position as vice president of Young & Eubicam, Inc. and director of its International Division, and that he would be required to divide his time between managing the London office, supervising European offices and directing the plaintiff’s program of foreign expansion. It was understood that Wilkerson was to receive part of his compensation from the British subsidiary for services as managing director of the London office, and part of his compensation from the New York corporation for the services he would continue to perform as plaintiff’s vice president. In April 1960, Wilkerson transferred the base of his operations to London, and he became managing director of the London office on July 1st of that year. During 1960 Wilkerson, in addition to his activities as manager of the London office, acted as a European marketing advisor for a number of plaintiff’s clients. In this capacity, he traveled extensively in Europe with client representatives from the United States, made a number of trips to client offices within the United States and acted as consultant to United States clients who were planning to enter the European market at that time.

26. Upon his arrival in Europe, Wilkerson formed a group of employees who assisted him, to varying degrees, in the proposed European expansion program. This group included : Thomas Reynolds, Alfred O. Buckingham, John F. Casey, Francis Gearon, Alexander Brody, Frederick W. Lacey and Andrew Schmitt. Wilkerson traveled extensively throughout Europe, negotiating with representatives of existing foreign agencies with a view to a possible merger, interviewing international clients in European cities where new offices were contemplated, preparing reports for plaintiff with respect to proposed offices or mergers and interviewing and hiring European talent to perform services for the new offices. At various times the other individuals performed similar services. As a result of these activities, plaintiff in a later period, acquired or formed five new subsidiary corporations in Europe and greatly expanded the scope of activities and its reputation as an international agency.

27. In 1964, Alfred O. Buckingham became managing director of Young & Rubicam, Ltd. and headed the London office for a period of six years. During 1959, in his capacity as vice president of the International Division, Buckingham supervised the activities of the European subsidiary offices for the purpose of reporting to the president and chairman of the board of the parent corporation. In addition, he acted as European liaison and marketing expert for many of the domestic clients of the parent company, constantly meeting with and entertaining high executives of the United States clients who were visiting in Europe on business, and consulting with and advising them on the opening of new offices and manufacturing plants in various European areas. In 1959 and early 1960 he was largely responsible for establishing a chain of associate agencies in eighteen European, countries through which New York International Services placed advertising in these foreign countries for its United States clients. He traveled throughout Europe investigating existing agencies for plaintiff. In 1960 he assisted Wilkerson in the planning and development of new subsidiaries in Europe.

28. Two other employees of Young & Rubicam, Inc., who had been transferred to London from the United States, also received part of their compensation from plaintiff — Thomas A. Reynolds and J. F. Casey had been assigned to the London office in the late 1940’s and in 1956, respectively. Each of them had long established contacts with important United States clients who were in the process of expanding their European operations in 1959 and 1960. As in the cases of Wilkerson and Buckingham, each of them (Reynolds and Casey) performed valuable contact services for the plaintiff and these United States clients, acted as their foreign marketing advisors, traveled with their representatives throughout the continent, assisted in the preparation of marketing reports for their benefit and paid visits to their United States offices to consult with their managements.

29. Reynolds was designated deputy director of European expansion in which capacity he prepared for plaintiff, studies of European advertising business potential, the total advertising volume of the various countries, analyses of such volume among the different media, etc.

30. John B. Waldron (who resided in London) was a British subject in the employ of Young & Rubicam, Ltd. In the latter part of 1960, because of services he was then performing for plaintiff, both in the United States and in England, in connection with two major clients of the parent company, he was paid a nominal amount of compensation by plaintiff.

31. Early in 1959 the plaintiff’s management became aware of the growing dissatisfaction of certain of its United States clients with the advertising services being performed for them by its German subsidiary. It recalled one of its former (retired) executives, Henry Lent, and retained him as a consultant to determine the causes and remedies for this condition. Lent remained in Germany for over six months, but did not become a regular employee of either Young & Eubi-cam G.m.b.H. or Young & Eubicam, Inc. His services contributed greatly to the solution and correction of the management difficulties which had plagued the Frankfurt office. The compensation for his services as an independent consultant, and his expenses, were paid by the plaintiff.

32. In November 1959, Wilkerson traveled to the Frankfurt office for discussions with Lent and others concerning the solution of the difficulties of that office. It was then decided to replace the Frankfurt manager. Upon his return to New York, Wilkerson immediately dispatched Alexander Brody (an employee of the New York office) to Frankfurt to initiate essential changes before the appointment of a new manager. Wilkerson and Buckingham met with Francis E. Gearon, who was then head of Contact Services in the London office, and received his consent for transfer at the end of 1959 to the Frankfurt office as managing director.

33. Francis E. Gearon became an employee of Young & Eubicam, Ltd. in 1955. He occupied a number of positions of increasing responsibility until 1959, when he was named head of Contact Services. In early 1959 he also began to work on behalf of the plaintiff company, assisting Buckingham in meeting with the plaintiff’s clients or prospective clients who were considering expanding their operations in various countries of Europe. During 1959, Gearon traveled both in Europe and to the United States in connection with the European marketing plans of some of the plaintiff’s largest United States 'clients. The trip which he made to the United States late in 1959, also included his meeting with some of the plaintiff’s clients who had expressed dissatisfaction with the services their German subsidiaries were receiving by the plaintiff’s German subsidiary. This was after Gearon had been chosen to replace the managing director of the plaintiff’s German subsidiary.

34. In January 1960, Gearon became managing director of the Frankfurt office, with Alexander Brody as his first assistant. At the same time, two New York Creative Department employees were temporarily assigned to the Frankfurt office — Frederick W. Lacey was assigned as head of the Copy Department and Andrew J. Schmitt as head of the Art Department. Each of these individuals received part of his salary from plaintiff. At times each assisted Wilkerson in plaintiff’s European expansion by traveling on its behalf throughout Austria, Italy, Belgium, France and Spain in efforts to negotiate mergers with existing agencies, to survey possibilities for offices in new areas and to interview prospective talent for such offices.

35. Gearon and his group of American employees achieved almost immediate success in improving relationships with major clients of the Frankfurt office and were able to retain the business which had been in jeopardy. The loss of these accounts might have necessitated the abandonment of the first continental office of Young & Kubicam, Inc. and might also have seriously interfered with the projected European expansion program. Further, the services of these employees in this expansion project contributed greatly to the ultimate formation and acquisition of many new offices abroad.

36. Brody’s services in early 1960 were instrumental in preserving the United States client business which was then in jeopardy. However, he did not wish to be aligned solely with the operation of the Frankfurt office and felt that his European expansion activities were too limited. When Brody notified Gearon of lfis intention to resign, Wilkerson arranged for a broadening of Brody’s European responsibilities on plaintiff’s behalf and, in view of the proposed increase in activities, procured an increase in his compensation from the plaintiff. During the balance of 1960, Brody spent a substantial part of his time with Wilkerson and Gearon traveling throughout the Continent in connection with the development of the European expansion program.

37. Joseph Vaamonde participated in the acquisition of the Penn-Zerbe advertising agency in Puerto Eico in 1956. He and Zerbe became co-managers of the San Juan office and continued in that capacity for several years. Vaamonde’s efforts were directed to the development of an office which was capable of meeting the standards established by plaintiff. At various times during 1959 and 1960, when special contact, copy or art services were required to meet emergencies which arose in connection with, clients of the Puerto Eican subsidiary who were also clients of plaintiff, various employees of plaintiff were transferred to Puerto Eico. These included John G. Hoyt, William Miller and Marc DeVos. Their activities were devoted to solving problems of the subsidiary corporation.

38. In February 1959, because of the sudden resignation of James S. Stanton, manager of the Mexican subsidiary, it was necessary to rush Vaamonde to Mexico City to fill that opening.

39. Vaamonde was selected to supervise the Latin American subsidiaries because of his knowledge of these markets, his fluency in the language and his previous association with Young & Eubicam United States clients which operated in this area. As in the case of other managers, he came in regular contact with United States client representatives who were traveling throughout Latin America and was consulted by them about their marketing problems in Puerto Eico, Mexico, Colombia, as well as other areas. He maintained these contacts with United States clients, both in Mexico and on his trips to their home offices in this country.

40. Because of the overlapping of markets in Latin American coimtries, Vaamonde frequently became involved in the preparation of advertising for United States clients in areas other than Puerto Eico and Mexico City which would be placed and billed by plaintiff’s New York International Services subdivision. Also, at the request of plaintiff’s New York International Services subdivision, he made two exploratory trips (in 1959 and 1960) to San Salvador, each of a week’s duration, to survey that market. The information secured on these trips was transmitted to the New York International Services subdivision and was utilized by it for the United States clients it serviced in this Latin American area.

41. The Caracas office of Young & Eubicam, Inc. was operated as a division of the New York corporation until it was separately incorporated in Venezuela in 1960. Miguel H. Martinez, a vice president of Young & Eubicam, Inc. had been acting as its manager since 1958. Prior to the date of the subsidiary incorporation, Wilkerson visited Caracas and informed Martinez that he was to continue as manager of that office but would remain an officer and employee of Young & Eubicam, Inc. In this capacity Martinez was the senior vice president of the company in Latin America. He was informed that he would eventually be responsible for the overall supervision of the entire Latin American area. In regard to plaintiff’s intention to expand its operations and offices in other Latin American countries, Martinez was delegated to investigate such possibilities and to keep Wilkerson posted on any opportunities which arose.

42. One of Martinez’ major responsibilities as vice president of Young & Eubicam, Inc. was the development of new advertising business in any part of Latin America. In 1960, his expense accounts indicate that he traveled to San Juan, New York, Chicago, Detroit and Mexico City.

43. Martinez’ duties also included contacting United States client executives on behalf of Young & Eubicam, Inc. (both within the United States and when they were visiting Latin America) and consulting with them concerning their marketing problems in the Western Hemisphere. These activities were intended to strengthen existing ties with these clients in Latin America and also to create goodwill for plaintiff in the United States.

44. In October 1960, Martinez was notified by plaintiff that he was to replace Yaamonde in Mexico City because the latter had been transferred to the New York office. Jack Hardy (an employee of the New York International Services subdivision) was sent to Caracas to replace Martinez there for the final three months of the year.

45. While on a trip to Mexico City in 1960, Martinez learned that Edward Noble (owner of the Noble Advertising Agency) was interested in a possible sale to or merger with one of the larger United States agencies, such as Young & Eubicam, Inc. Martinez notified both Wilkerson and Hagen of his conversations with Noble. In November 1960, Eichard Penn (and other executives of Young & Eubicam, Inc.) went to Mexico City and reviewed with Martinez the possibilities of the Noble acquisition. Plaintiff’s interest centered upon the fact that the Noble agency had sizable billings throughout Latin America, had branch offices outside of Mexico City and its acquisition would facilitate rapid expansion throughout Central and South America.

46. Martinez continued to meet with Noble and the merger of plaintiff’s three Latin American subsidiaries with the Noble Advertising Agency (under the name of Young & Kubicam-Noble) took place in the fall of 1961. As a result of this merger (which had been initiated and sponsored by Martinez in 1960) plaintiff greatly expanded the scope of its operations in Latin America and thereafter maintained offices in Mexico, Panama, San Salvador, Puerto Eico and Venezuela.

47. In January 1960, Ollie Lyon (an account executive in the New York office) was hurriedly transferred to Toronto in an effort to improve the service to one of plaintiff’s important clients by its Canadian subsidiary, and to restore the favorable relationship which had existed with this client. Time did not permit negotiations concerning his compensation from the plaintiff during his temporary assignment in Toronto. However, prior to his departure from New York, Lyon was informed by Wilkerson that he would try to arrange for partial compensation from the plaintiff for services Lyon would perform for plaintiff while in Toronto. In December 1960 Wilkerson advised the plaintiff’s treasurer (Farrand) that Lyon’s services during the year had been particularly valuable to the plaintiff, and as a result it was arranged that Lyon should be paid a year-end bonus by the plaintiff.

48. Similarly, when Jose L. Brandi was selected as manager of the Puerto Eico office during 1960, because of the suddenness of the change no immediate arrangement was made to compensate him for services he would perform for the plaintiff. However, Wilkerson was instrumental in rectifying this oversight by arranging (in December of that year) for the payment of a nominal amount of year-end bonus by the plaintiff.

49. Many of the clients represented by the plaintiff’s New York office were engaged in international marketing and advertising. Each of them utilized the services of one or more of plaintiff’s foreign subsidiaries for the preparation and placement of advertising abroad.

50. Plaintiff’s employees who were assigned to perform their services abroad received the following amounts of compensation in 1960 from the plaintiff and its subsidiaries (including salary, bonus, profit sharing trust and group insurance):

Employee Country Compensation Y & R, Inc. Subsidiary

Austin, Eugene. Brandi, Jose L. Brody, Alexander. Buckingham, Alfred 0 Casey, John F. DeVos, Marc. Gearon, Francis. Hardy, Jack G. Hoyt, John G. Lacey, Frederick W__„ Lyon, Ollie M. Jr. Martinez, Miguel. Miller, William D. Nussbaum, John. Reynolds, Thomas A__ Schmitt, Andrew J._._ Vaamonde, Joseph H.. Waldron, John B. Wilkerson, James P___. Puerto Rico. Puerto Rico. Germany. England.. England. Puerto Rico. Germany. Venezuela. Puerto Rico. Germany. Canada. (V enezuela_ (Mexico. Puerto Rico. Germany. England. Germany. [Mexico. (New York (USA). England_ England. $5,644.98 1,600.00 9,899.17 45,181.11 16,970.84 6,827.51 8,561.53 11,016.34 12,783.69 10,461.68 8,500.00 } 22,805.52 7,298.95 1,416.06 6,123.22 10,250.72 } 15,956.38 1,537.37 38,287.65 $16,500.00 9,626.00 13,258.00 13,252.00 10,833.00 9,750.00 22,885.48 555.00 18,900.00 8,760.00 8,714.00 16,214.00

51. In connection with the transfer of plaintiff’s employees to and from their foreign positions, and the services which plaintiff alleges they performed for it, plaintiff paid the following expenses during the year 1960:

Employee Enter- Moving & Travel Mise, tainment living

Austin, Eugene_ $43.35 Berry, Norman C. Brody, Alexander... Buck, Richard L.. Burnett, Theodore S. Jr. Casey, John F. Debrot, Cornelio.... DeVos, Marc. 75.35 Farrand, George N. Gearon, Francis. 181.75 Hagen, Ward_ __ Hardy, Jack G. 162.48 Hicks, Harry. Lacey .Frederick W. Maries, Robert. 45.60 Martinez, Miguel. 2,319.17 Miller, William. $1,642.00 ' 1,157.16 3,850.76 ‘í,"móó '8,168.77 1,105.60 6,280.78 12,305.83 2,594.91 1,716.43 $485.36 105.51 562.00 76.67 45.65 184.14 113.63 668.65 91.58 69.01 1,669.49 1,987.22 619.60 1,592.20 1,494.90 811.40 3,339.96 175.00 $1.80 4.30 8.61 3,210.01 10.75 427.37

_rlaLViiba. juúopu IN..........._ Penn, Richard. 358.87 Schmitt, Andrew J.. Tragos, William. Vaamonde, Joseph H. Waldron, John B.__. 26.00 Wilkerson, James P.... 275.64 Non-Employee Payments.... 5,129.40 168.39 2,192.08 443.48 1,891.20 1,927.88 540.00 68.66 1,106.50 3,463.55 13.29 34.07 33.00 3,833.36

52. The payments made in 1960 (referred to in findings 50 and 51) were disallowed as deductions by the Commissioner of Internal Eevenue. At the beginning of trial, the defendant conceded that some of these payments were ordinary and necessary business expenses of Young & Eubicam, Inc., as incurred for the management, conservation or maintenance of property held for the production of income. These payments included the $40,000 compensation of James Wilkerson ($13,000 allocable to the period January 1, 1960 through April 19, 1960 and $27,000 allocable to the period April 20, 1960 through December 31, 1960) and payments made to or for the following employees for the following purposes:

Employee Entertainment Travel Mise.

DeV os, Mare. $54.00 Farrand, George. Hagen, Ward. Hardy, Jack. 72.52 Plazonta, Joseph N. Penn, Richard. 358.87 Wilkerson, James P__,. 275.64 $91.58 1,669.49 933.00 1,891.20 3,463.55 $8. 61 13.29 34.07

The defendant conceded at pretrial that the plaintiff was entitled to deduct $25,000 from its 1960 income for contributions to the Young & Eubicam Foundation and the Young & Eubicam Scholarship Fund.

53. The audit of the plaintiff’s federal income tax return for the year 1959 was conducted by Internal Eevenue agent Sol Babinowitz. In this audit he questioned the deductions taken by the taxpayer for compensation paid to certain of its employees in foreign countries. After examining into the specific services performed by these individuals, and determining that they devoted part of their time to the taxpayer and part to its subsidiary, he reached a compromise with the taxpayer’s representatives by allowing a portion of their compensation for services abroad (and related expenses) and disallowing a portion thereof. The disallowed items were the subject of the 1959 claim for refund and are in issue in this case. The compensation and expenses allowed and disallowed for each employee are as follows:

1959 1969 1959 1959 Employee compens. expenses compens. expenses allowed allowed disallowed disallowed

Austin, E_ Brody, A. Buckingham, A... Casey, J. F. Gaudier, O. A--.. Gearon, F. Heumann, W. Hoyt, John G____ Lent, H. B._ Nussbaum, J_— Olmstead, R.. Reynolds, T. A... Stanton, J. S._ Vaamonde, J. H.*. Zerbe, A.. $8,889.00 . . $2,779.43 27,590.77 . 14,211.90 . 1,877.49 5,326.54 15,456.12 5,584.76 . 1,408.05 . 10,465.58 8,999.93 6,114.96 . . $1,297.48 $4,488.54 2,799.43 14,332.77 . 4,018.29 1,450.00 . "4,566.6o "I""""” '"4,491.26 mu””"" ”í,ió8."ó5 10,465.58 3,999.93

54. During his audit of the 1959 return, the agent examined the taxpayer’s books, records and accounting procedures. He found that plaintiff had a good and complete accounting system which was regularly audited by an internationally known accounting firm. He found no accounting improprieties nor any indication that the taxpayer was attempting to evade taxes or to shift income from one company to another.

55. The audit of plaintiff’s 1960 return (which was also assigned to agent Rabinowitz) commenced on June 20, 1962. On January 3,1963, an agent from the New York section of the Office of International Operations of the Internal Revenue Service (sometimes referred to hereafter as OIO) was assigned to assist and advise Rabinowitz. Thereafter, the two agents conducted the audit jointly, and finally completed the examination in August 1963. During this extensive audit, the examining agents requested and examined a substantial quantity of the plaintiff’s correspondence files, records and other documents pertaining to the employees whose function it was to communicate with foreign subsidiaries. Plaintiff and its representatives were completely cooperative and produced all documents and information requested of them.

56. A final conference was arranged between the Revenue agents and plaintiff’s representatives after the completion of the 1960 return audit. At this conference, the OIO agent (Irving ITberall) stated that he was proposing to recommend a deficiency based in part upon an allocation to plaintiff (under section 482 of the Internal Revenue Code) of portions of the gross income of its subsidiaries, because of management and administrative services performed for these subsidiaries by the executives of the parent company. The agent stated the total amount of these constructive management fees which he proposed to tax to the plaintiff, but did not provide any information concerning the basis, method of computation or the specific allocation from each subsidiary which was proposed. Plaintiff’s representatives promptly rejected this proposal and informed the agents that the plaintiff intended to take the matter to a higher administrative level or to the courts, whereupon the meeting was terminated without any further discussions.

57. On August 15, 1963, the Director of International Operations of the Internal Eevenue Service in Washington sent a letter to the plaintiff reading as follows:

We propose to recommend to the District Director of Internal Eevenue, Manhattan, New York, allocations of your income and deductions under Section 482 of the Internal Eevenue Code.

A statement of allocations under consideration is set forth below. The amounts and the basis for the adjustments are subject to change. This information is furnished to enable you to notify your related foreign entity of the proposed action. It may want to protect itself against the possible expiration of foreign statute of limitations on allowance of a potential offsetting foreign tax adjustment. Technical Information Eelease 491 is attached.

We want to emphasize that the office of the District Director named above has jurisdiction of the “international issues” involved in your case.

Very truly yours,

Director of International Operations

Allocations under consideration Attachment TIR-491

Young & Rubicam, Limited (England)_$38,476.00

Young & Rubicam, Ltd. (Ganada)_ 50,787.00

Young & Rubieam, Mexico, S.A_ 4, 608. 00

Young & Rubicam De Venezuela, S.A_ 16, 410. 00

Young & Rubicam Puerto Rico, Inc_ 7,805. 00

Young & Rubicam, G.m.b.H_ 13, 937. 00

Young & Rubieam, S.A. (Switzerland)_ 1,092.00

As an enclosure to the letter quoted above (which it is noted did not specify the taxable year involved), there was a Technical Information Release, dated July 17, 1968 (TIE, 491) which reads as follows:

FOE RELEASE

Wednesday, July 17, 1963

The Internal Revenue Service suggested today that domestic taxpayers should apprise foreign affiliates, to take such protective action as may be necessary with foreign taxing authorities, including the filing of protective claims for refund, in those instances where Internal Revenue is considering or proposing a reallocation of income or deductions between the related business entities. Timely action along such lines may prevent cases where both entities pay tax on essentially the same items of income.

Expanded auditing by Internal Revenue of taxpayers with foreign affiliates may result in an increasing number of cases where there is a reallocation of income, deductions or credits between a domestic and foreign entity with a consequent increase in the United States tax liability of the domestic taxpayer. Such realloca-tions may justify compensatory adjustments in the foreign tax liability of the foreign affiliated enterprise.

However, unless appropriate steps are taken by the foreign affiliate to stay the expiration of the statute of limitations applicable in the foreign country, it may be unable to obtain a refund or other tax adjustment that would otherwise be appropriate, with the result that the aggregate taxes paid by the related entities will be higher than is necessary.

While tax treaties between the United States and a number of other countries provide for negotiations between the competent tax authorities of the two countries when double taxation occurs or is likely to occur, such negotiations are often time-consuming and may be ineffective unless timely action is taken by the taxpayers involved to preserve their rights under the tax statutes of the two countries.

Consequently it is suggested that United States taxpayers advise their foreign affiliates to take such steps abroad as may be required for their protection as soon as possible after a reallocation of the income, deductions or credits of the domestic entity is indicated by an Internal Revenue Service examining officer.

58. The final report of OIO agent Irving Uberall was dated August 22, 1968, and was received by the New York District Director on October 22, 1963. It enumerated the assumptions and facts upon which the agent supported his recommendation that section 482 be invoked and offered the District Director two alternative recommendations for computations of management fees to be allocated from the subsidiaries. This report became part of the District Director’s administrative file, but its contents were not revealed to the taxpayer until shortly before the trial of this case.

59. The OIO report indicates that from an examination of the plaintiff’s correspondence and other documents the agents learned that in 1960 plaintiff had charged a management fee to its British subsidiary for special services performed by the top management of Young & Rubicam, Inc., namely, Sigurd S. Larmon (chairman of the board), George Gribbin (president), George N. Farrand (treasurer) and Dwight F. Smith (assistant treasurer). The invoice sent to the subsidiary on December 8, 1960, reads as follows:

Annual Management Fee for the Tear 1960_$50, 000. 00

Based on the cost of the special services rendered by the top management of Young & Rubicam, Inc., and its Accounting and International Departments, on behalf of Young & Rubicam, Limited.

Less estimated services of Young & Rubicam,

Limited, rendered on behalf of clients of

Young & Rubicam, Inc_ 15, 000. 00

Net fee_$35, 000. 00

60.Because the aforementioned fee had been charged to one subsidiary, the OIO agent concluded (despite the denials of the plaintiff) that similar services must have been rendered to every one of plaintiff’s subsidiaries. The theory of his position is stated in his report as follows:

❖ ❖ * #

It is reasonable to accept the general thesis that in order to protect one’s investment (dependent upon the extent of such investment), a greater or lesser amount of administrative and managerial effort will be devoted to such pursuit.

Examination of taxpayer’s correspondence with its foreign affiliates suggests constant and continuing supervision. * * *

The agent’s view was that this constant supervision for the purpose of protecting plaintiff’s investment constituted management services, the value of which should have been charged to the subsidiaries. Accordingly, he recommended the following methods for computing and allocating such fees: (a) The OIO agent made the preliminary assumption that the $50,000 London fee could not be questioned and that it was, therefore, “being accepted and being employed as a basis for the computation of comparable pro-rata fees to be allocated from their other foreign affiliates.” There is no indication in the report as to which employees were involved, what services were performed, which subsidiaries were directly benefited, how the value of the services was computed or why it was appropriate to allocate an amount similar to the London fee to other subsidiaries, (b) The gross fee charged to the London office ($50,000) is then allocated in the report to each subsidiary by the following formula:

Commission Income Earned By Foreign Affiliate $2,759,593 x $50,000 [London commissions]

Germany Service and- managerial fee due Y <6 B (.domestic)

$434,692 x $50,000 = $7,876 $2, 759, 593

Switzerland

$34,046 x $50,000 = $617 $2, 759, 593

Venezuela

$252, 191 x $50,000 = $4,569 $2, 759, 593

Puerto Rico

$243,449 x $50,000 = $4,411 $2, 759, 593

Mexico

$143,728 x $50,000 = $2,604 $2, 759, 593

Canada

$1,584,044 x $50,000 = $28,701

$2, 759, 593 -

Total_$48, 778

(c) The OIO agent then determined that in addition to the abovementioned services performed by the taxpayer’s top management, other employees in its New York Internationa] Services subdivision also performed management services for the subsidiaries. Eelying entirely upon a sentence contained in a memorandum prepared by the head of this subdivision to the effect that one-third of its employees’ time was spent in dealing with United States international clients on behalf of Young & Eubicam’s foreign subsidiaries, the agent concluded that this afforded a sound basis for disallowing one-third of this subdivision’s total operating expenses of $228,032. No part of the amount so disallowed was allocated to any one subsidiary — it was added to the previous allocations in the following maimer:

New York International Department Expense_ $76, 011

Use of $50,000 Eee from England as a basis_ 48, 778

Total -$124, 789

(d) An alternative method of determining management fees was also suggested in the report. This method utilized a formula which applied to the total compensation paid to the taxpayer’s top management, the ratio which the subsidiaries’ total 1960 commission income bore to the parent company’s commission income. The computation of this alternative method was as follows:

$5,451, 743 35,646,924 $527,291 = $80,642

N.Y. International. (See prior computation). 76, 011

Total -- $156,653 Less: Eee Paid by England_ 50,000

Estimated Fee for Managerial and Administrative Services for Foreign Subsidiaries other than England_$106,653

61. The evidence relied upon by OIO agent Uberall to support his conclusion that management services were performed for all of the taxpayer’s subsidiaries was contained entirely in the taxpayer’s correspondence files, excerpts from which are quoted in bis report. This correspondence does show that plaintiff’s management sought to supervise its subsidiaries’ operations in order to protect its investment abroad, but it does not contain any evidence of its performance of management, administrative or other services for the direct benefit of the subsidiaries (other than its British subsidiary).

62. Neither agent questioned any of the plaintiff’s employees during the course of the audit to ascertain what specific services (if any) were performed by them for the subsidiaries, or which of plaintiff’s employees were required to provide such services, or the particular subsidiaries for which the services were performed, or the extent and value of the services to each subsidiary. The agents’ reliance upon an office memorandum prepared by one of plaintiff’s employees to support disallowance of one-third of the operating expenses of the New York International Services subdivision proved to be misplaced, since the testimony revealed that the memorandum referred to only two employees in that subdivision (out of a total of 29 employees) and that the services performed were for the benefit of the plaintiff’s domestic clients and not for the subsidiaries.

63. On November 20,1963, agent Babinowitz issued a statement of his proposed adjustments (on Form 2808), a copy of which was mailed to the taxpayer. This so-called 10-day letter stated that $124,789 of gross income of taxpayer’s foreign subsidiaries (except England) was allocable to the taxpayer for management services performed. This notice contained no explanation of the basis for the proposed determination and made no specific allocation of gross income from each subsidiary.

64. Thereafter, on April 24, 1964, a statutory notice of deficiency (90-day letter) was issued to the taxpayer (relating to the taxable year ended December 31, 1960) in which a deficiency of $262,201.82 was shown. An enclosure to this form letter was the only explanation offered to the plaintiff by the Commissioner of Internal Bevenue of the manner in which such deficiency was reached by the Commissioner. This was in the form of a statement which reads in full as follows:

Statement Young & Eubicam, Inc. 285 Madison Avenue New York 10017, New York

Tax Liability for the Taxable Year Ended December 31, 1960

Income Tax

Taxable Year Ended Assessed Liability Deficiency

December 31, 1960. $1,273,064.74 $1,636,266.56 $262,201.82

The deficiency is based on adjustments and explanations as set forth in detail below.

A copy of this letter and statement has been mailed to your representative, Sandow Holman, Esq., 521 Fifth Avenue, New York, New York, in accordance with the authority contained in the power of attorney executed by you.

Adjustments to Income

Taxable income disclosed by return. Unallowable deductions and additional income: $2, 485, 807. 21

(a) Expenses on behalf of foreign affiliates_ $325, 754. 86

(b) Income allocatedfrom foreign subsidiaries_ 124, 789. 00

(c) Income attributable to use of interest-free funds_ 8, 325.12

(d) Amortization_ 33, 024. 38

(e) Contributions_ 25, 850. 00

(f) Initiation fees_ (g) Documentary stamp taxes_ 2, 475. 00 469. 00 520, 687. 36

Total__ $3, 006, 494. 57 Additional deductions and nontaxable income:

(h) Social security taxes_ $16, 113. 00

(i) Other taxes_ 321. 20

16, 434.20

Taxable income as adjusted_$2, 990, 060.37

Explanation of Adjustments

(a) Expenses enumerated below incurred in behalf of various foreign affiliates and deducted on your return, have been disallowed inasmuch as you have not established same as allowable under any of the sections of the Internal Revenue Code.

Salaries and bonuses-$218, 991. 61

Profit-sharing contributions- 23,219.40

Group insurance_ 1, 791.41

Audit and legal- 1, 646.52

Auto expense- 510. 97

Business lunches- 125. 76

Dues and subscriptions- 326.95

Entertainment- 3,488.21

Pares_ 102.68

Miscellaneous- 135. 36

Moving and living expenses- 47,127.91

Outside services- 3,169. 04

Overtime meals_ 52.20

Postage and expressage- 929.33

Stationery and supplies- 948. 03

Telegraph and telephone- 99. 72

Travel_ 23, 089.76

Total_$325,754.86

(b) It has been determined that you realized additional taxable income in the amount of $124,789.00 which has been allocated to you from the gross income of various of your controlled foreign subsidiaries for management and administrative services performed for them.

(c) It has been determined that you realized additional taxable income in the amount of $8,325.12 which has been allocated to you from the gross income of Young and Rubicana, De Venezuela, South America for the use of funds advanced to this subsidiary without interest charges.

(d)-(g) inclusive — Your claimed deductions for amortization, contributions, initiation fees and documentary stamp taxes have been disallowed to the extent indicated inasmuch as they have not been established by you as allowable under any of the sections of the Internal Revenue Code.

(h) & (i) You have been allowed an additional deduction of $16,113.00 for Social Security taxes and a deduction of $321.20 for New York State Franchise and New York Gross Receipts taxes accruable as at December 31, 1960, which were not deducted on your return.

Computation of Tax

Taxable income as adjusted_$2,990, 060.37

Tax on $2,990,060.37 (alternative method)- 1, 549, 209.45

Less: Foreign tax credit_ 13,942. 89

Corrected income tax liability_ 1, 535, 266.56

Income tax liability disclosed by return_ 1,273, 064. 74

Deficiency in income tax_ $262, 201. 82

65. It is noted by reference to the statement quoted above that the Commissioner of Internal Revenue made no determination that the allocation indicated therein was “necessary in order to prevent evasion of taxes or clearly to reflect the income” of the plaintiff or its subsidiary companies.

66. The plaintiff was the controlling stockholder in each of its foreign subsidiaries and was in a position to dictate their dividend policies. Its long established policy was to have these subsidiaries (as soon as they developed any substantial earnings) return these profits to the parent corporation in the form of dividends. The amounts of the dividends paid to the plaintiff by each of the subsidiaries during the years 1958 through 1964 inclusive were as follows:

Year Subsidiary Dividend

1958 Young & Rubicam, Ltd. (England). $25,800.25

Young & Rubicam, Ltd. (Canada).. 23,704.22

Total... $49,504.47

1959 Young & Rubicam, Ltd. (England). $44,658.31

1980 Young & Rubicam, Ltd. (England)... $26,911.64

1961 Young & Rubicam, Ltd. (England). $141,451.60

1962 Young & Rubicam, Ltd. (England). $1,551,971.33

Young & Rubicam, G.m.b.H. (Germany)... 305,092.33

Young & Rubicam, Ltd. (Canada). 92,753.62

Total. $1,949,817.28

1963 Young & Rubicam, Ltd. (England). $404,913.24

Young & Rubicam, G.m.b.H. (Germany)... 528,676.10

Young & Rubicam, Ltd. (Canada). 69,216.00

Young & Rubicam (Puerto Rico) Corp. 20,000.00

Total. $1,022,805.34

1964 Young & Rubicam, Ltd. (England).. $501,258.63

Young & Rubicam, G.m.b.H. (Germany). 151,174.53

Young & Rubicam, Ltd. (Canada). 52,455.71

Young

Total. $754,888.77

67. The net profits or losses (after taxes) of the plaintiff corporation and each of its foreign subsidiaries for the calendar year 1960 were as follows:

Young & Rubicam, Inc. (United States)- $1,212, 742.47

Young & Rubicam, Ltd. (England)-496,199.00

Young & Rubicam, G.m.b.H. (Germany) (subsidiary of England)_ 2, 974. 00

Young & Rubicam, S.A. (Switzerland) (subsidiary of England)-5,268.00

Young & Rubicam, Ltd. (Ganada)-9,143.00

Young & Rubicam, Mexico, S.A_ (64,383. 00)

Young & Rubicam de Venezuela, S.A_ 2, 730. 00

Young & Rubicam (Puerto Rico) Corp-(8, 837.00)

CONCLUSION OK LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover a refund in accordance with the foregoing opinion.

Judgment is entered to that effect with the determination of the exact amount to be reserved for further proceedings pursuant to Eule 47 (c).

We are indebted to Trial Commissioner William B. Day for Ms opinion, findings of fact and recommended conclusion of law. We have adopted much of what the commissioner has written and arrive at similiar conclusions for different reasons.

United States Code, 1964 Ed., Title 26, § 162 :

Ҥ 162. Trade or business expenses.

“(a) In general.

“There shall be allowed as a deduction all the ordinary and necessary Expenses paid or incurred during the taxable year in carrying on any trade or business, including—

“(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

“(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances [) ] while away from home in the pursuit of a trade or business; * *

As a set-off issue, defendant lias raised tlie deductibility of expenses paid to two individuals not included in the Commissioner’s deficiency assessment.

In summary, the record establishes the following Information: Austin was the manager of the Young & Rubicam Puerto Rican corporation. Brandi replaced Austin. Miller was the art director and a supervisor in Puerto Rico. Hoyt was the creative head of the San Juan office. DeVos was the assistant manager for client services in the San Juan office. Zerbe serviced many of the accounts of the Penn-Zerbe agency which Xoung & Rubicam, Inc. had acquired. Hardy was the managing director in Venezuela for the last few months of 1960. Nussbaum was employed in the German subsidiary. Gaudier was transferred from Toronto to Germany where he worked with the problems posed by the television media in Germany.

Lyon presents a unique situation. Plaintiff paid him a bonus for his activities in solving the problems of a Canadian division of a major domestic client who was dissatisfied with the services of plaintiff’s Canadian subsidiary. The subsidiary received the direct benefit of Lyon’s activities and plaintiff is not justified in deducting compensation it paid him.

The precise amount of the deduction allowable for each Individual, however, Is reserved for the trial commissioner’s determination.

The activities of Casey were discussed above, on the basis of which plaintiff may deduct the salary paid in 1960.

United States Code, 1964 Ed., Title 26, § 482 :

Ҥ 482. Allocation of income and deductions among taxpayers.

“In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the united States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.”

At trial, defendant conceded the deductibility of part of Wilkerson’» salary because he did not perform any of the day-to-day functions of the London office. Part of that concession reaffirms our conclusion that he performed general supervisory activities on plaintiff’s behalf.

“To the extent that payments were made while Mr. Wilkerson was engaged in associated business and international business while he was in the united States [January 1 through April 19, 1960], he was performing services in taxpayer’s trade or business.

“While he was abroad and to the extent that he was also working in the international division, his services were of an investment nature, the kind that a corporation may properly pay to top executives who supervise their investments, being here subsidiary corporations.

“* * * [H]e was the one individual abroad who did have this supervisory control over, not just one corporation and therefore engaged in the trade or business of the subsidiary corporation, but he was supervising three corporations and he was looking for new investments, Paris, Italy, Belgium and other places * * *. [,Tr. S3-84]”

These figures appear to be inconsistent, but they are the figures which appear in plaintiffs exhibits 4 and 5 supporting this finding.

Subsidiaries’ commissions.

Executive compensation.

Taxpayer’s commissions.

As per plaintiff’s 1960 income tax return.