## Facts

- Procter & Gamble Co. (P&G) owned a Swiss subsidiary, Procter & Gamble A.G. (AG), which paid P&G “package fee” royalties tied primarily to net sales for the use of P&G intangibles and related services.
- P&G organized a wholly owned Spanish subsidiary, Procter & Gamble España S.A. (España), to manufacture and sell products in Spain.
- Spain regulated outbound payments to foreign residents and criminalized unauthorized transfers; Spain approved España’s formation but expressly prohibited it from paying royalties or technical-assistance fees abroad, and later rules continued to bar or tightly restrict such technology-transfer payments during 1978–1979.
- The Commissioner invoked I.R.C. § 482 to allocate to AG royalty income that España allegedly would have paid under arm’s-length dealing absent Spanish restrictions.
- The § 482 allocation increased P&G’s Subpart F income under I.R.C. § 951(a)(1)(A), producing asserted deficiencies of about $1.2 million (1978) and $1.8 million (1979).
- The Tax Court rejected the allocation, finding Spanish law effectively barred the royalties during the relevant years and therefore there was no deficiency; the Commissioner appealed.

## Issues

1. Whether I.R.C. § 482 permits allocating to AG royalty income purportedly owed by España when Spanish law effectively prohibited España from making royalty and related technology payments during 1978–1979.
2. Whether blocked-income regulations, or hypothetical alternatives (dividends or corporate restructuring), justified allocating the blocked royalties under § 482.

## Decision

- The Sixth Circuit affirmed the Tax Court.
- Spanish law created a genuine legal barrier to the royalty payments; § 482 did not permit treating the royalties as realized income when they could not lawfully be paid.
- Blocked-income concepts did not require recognition or allocation of royalty income where the relevant category of payments was prohibited, not merely delayed or subject to routine exchange controls.
- The Commissioner could not use § 482 to compel hypothetical transactions (dividends) or restructuring (e.g., liquidation) to reach a tax result inconsistent with the taxpayer’s actual structure and the foreign-law constraints.

## Legal Principles

- I.R.C. § 482 authorizes reallocations among commonly controlled entities only to prevent tax evasion or to clearly reflect income based on the parties’ actual transactions.
- When foreign law effectively prohibits a controlled entity from making the asserted royalty (or similar) payments, § 482 does not allow the Commissioner to allocate to a related entity income that could not, in fact, be realized through those payments in the tax years at issue.
- Blocked-income rules do not mandate a § 482 allocation where the restriction is a substantive legal prohibition on the payment type, rather than a remittance or timing limitation.
- § 482 generally does not require taxpayers to adopt alternative dividend policies or reorganize corporate structure to maximize U.S. tax.

## Conclusion

The Sixth Circuit held that because Spanish law effectively barred España from paying royalties and similar technology-transfer fees during 1978–1979, the Commissioner could not use § 482 to allocate those hypothetical royalties to AG and thereby increase P&G’s Subpart F income; the Tax Court’s determination of no deficiency was affirmed.


Procter & Gamble Co. v. Commissioner, 961 F.2d 1255 (6th Cir. 1992)