## Facts

- Bausch & Lomb, Inc. (B&L) manufactured and sold soft contact lenses and related products worldwide through subsidiaries.
- B&L formed Bausch & Lomb Ireland, Ltd. (B&L Ireland), a wholly owned Irish subsidiary, to manufacture lenses in Ireland and benefit from Irish tax incentives tied to export manufacturing.
- Effective January 1, 1981, B&L licensed B&L Ireland nonexclusive rights to use patented and unpatented manufacturing technology (including “spin cast” know-how) and certain trademarks for worldwide sales of lenses produced using the technology.
- In exchange, B&L Ireland agreed to pay B&L a royalty equal to 5% of sales.
- During 1981 and 1982, B&L Ireland sold all production to B&L or B&L’s foreign affiliates at $7.50 per lens; purchasers paid additional freight and duty costs.
- The Commissioner issued deficiency determinations for B&L’s consolidated group, reallocating substantial income from B&L Ireland to B&L under I.R.C. § 482 and making correlative adjustments, including elimination of B&L Ireland’s royalty deductions.
- The Commissioner’s adjustment effectively treated B&L Ireland as a contract manufacturer by imposing a net-profit limitation (a profit-cap approach) rather than pricing the intercompany transfer price and royalty separately.

## Issues

1. Whether the Commissioner’s § 482 reallocations were arbitrary, capricious, or unreasonable.
2. Whether the $7.50 per-lens intercompany sales price was arm’s length under applicable transfer-pricing rules.
3. Whether the 5% royalty for the licensed manufacturing technology and trademarks was arm’s length, and if not, what arm’s-length royalty should apply under Treas. Reg. § 1.482-2(d).
4. Whether the Commissioner could disregard the separate economic significance of the transfer price and royalty and instead impose an overall profit cap on B&L Ireland.

## Decision

- The Tax Court held the Commissioner abused discretion under § 482 in rejecting the $7.50 per-lens price as non-arm’s length, where comparable uncontrolled prices supported that transfer price.
- The Tax Court held the 5% royalty was not arm’s length, but also held the Commissioner’s royalty adjustment (built around a profit-cap concept) was unreasonable.
- Applying Treas. Reg. § 1.482-2(d), the Tax Court set an arm’s-length royalty substantially higher than 5%, approximately 20% of net sales, while leaving the $7.50 transfer price intact.
- The Tax Court rejected collapsing the transfer price and royalty into a single profit-based reallocation; each term had independent significance and had to be evaluated as structured.
- The Tax Court substantially reduced the net § 482 reallocations for the years at issue.
- The U.S. Court of Appeals for the Second Circuit affirmed.

## Legal Principles

- Under I.R.C. § 482, the Commissioner may reallocate income among controlled entities to prevent tax evasion or clearly reflect income, but the determination may be set aside if arbitrary, capricious, or unreasonable.
- The arm’s-length standard generally requires evaluating controlled transactions by reference to how unrelated parties would price the same or similar transactions.
- For tangible-property transfers, reliable comparable uncontrolled price evidence can be controlling; a profit-based approach is disfavored when comparables reasonably support a price.
- For intangible-property licenses, Treas. Reg. § 1.482-2(d) governs determining an arm’s-length royalty; a royalty must reflect the value of the intangibles and the economics of the arrangement, even when exact comparables are unavailable.
- Section 482 does not authorize disregarding economically meaningful transaction structure to impose an aggregate profit cap where the intercompany terms can be priced separately under the arm’s-length standard.

## Conclusion

The Tax Court upheld B&L’s intercompany lens price as arm’s length based on comparable uncontrolled pricing, increased the royalty to an arm’s-length level under the intangible-royalty regulation, and rejected the Commissioner’s effort to recharacterize the arrangement through an overall profit cap; the resulting reduced § 482 reallocations were affirmed on appeal.


Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525 (1989)