                          T.C. Memo. 1999-134



                      UNITED STATES TAX COURT



  GAC PRODUCE CO., INC., AN ARIZONA CORPORATION, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 26700-95, 9347-96.      Filed April 21, 1999.



     J. Michael Traher, for petitioner.

     Marikay Lee-Martinez, Rachael J. Zepeda, and J. Robert

Cuatto, for respondent.


              MEMORANDUM FINDINGS OF FACT AND OPINION


     PARR, Judge:   Respondent determined deficiencies in, and

additions to or penalties on, petitioner's Federal income taxes

as follows:
                                               - 2 -

                                           Additions to Tax or Penalties
                           Sec.         Sec.         Sec.       Sec.      Sec.      Sec.       Sec.
 FYE       Deficiency   6651(a)(1)   6651(a)(2)   6653(a)(1)   6661(a)   6662(a)   6662(d)    6662(e)

6/30/89    $1,200,812   $300,203       --         $60,041    $300,203      --         --          --
6/30/90     1,976,911    494,228       --            --          --        --      $268,434   $253,897
6/30/91     1,741,876    435,469       --            --          --        --       206,786    283,178
6/30/92       741,723     33,730     $3,748          --          --     $149,911      --          --


          Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

          After concessions,1 the issue for decision is whether the

commission fees petitioner received from certain related entities

constituted arm's-length charges for the services rendered.                                    We

hold that petitioner did not receive an arm's-length commission

rate and that the commission rate should be adjusted as stated

herein.

                                       FINDINGS OF FACT

          Some facts have been stipulated and are so found.                           The

stipulation of facts, supplemental stipulation of facts, and

attached exhibits are incorporated herein by this reference.

When it filed its petitions, petitioner had its principal office

in Nogales, Arizona.

          Petitioner, an Arizona corporation, is in the business of

distributing and marketing in the United States fresh produce

grown mostly in Mexico.                Petitioner files its Federal corporate



          1
           See appendix.
                              - 3 -


income tax returns on an accrual basis, using a tax year ending

June 30.2

     During the years in issue, Alejandro Canelos Rodriguez (Mr.

Canelos) owned 57 percent of petitioner's common stock.    His

cousin, Basilio Georgacopulos Kanelopulos (Mr. Kanelopulos),

owned 40.5 percent of the common stock, and Mr. Canelos' sister,

Juana Canelos de Castro, owned the remaining 2.5 percent.    During

those years, Mr. Canelos served as petitioner's president and

chairman of the board of directors, and Mr. Kanelopulos served as

its treasurer.

     During the years in issue, petitioner had warehouse

operations in both Arizona and California.   Petitioner handled

produce year-round and was considered to be a major distributor

of fresh produce, in a normal year averaging 17 percent of the

entire U.S. fresh market tomato imports.   Petitioner held a

license issued by the U.S. Department of Agriculture (DOA)

pursuant to the Perishable Agricultural Commodities Act (PACA),

ch. 436, secs. 3 and 4, 46 Stat. 531, 533, which permitted it to

sell and distribute produce in the United States.   Petitioner's

main source of income came from providing produce distribution

services, and most of its costs were associated with providing


     2
      Petitioner used a fiscal year ending Sept. 30 until Sept.
30, 1987. After that date, petitioner changed its accounting
period to a fiscal year ending June 30 for both book and income
tax purposes.
                               - 4 -


those services.   Petitioner's major expenses were fixed costs,

although it had some capital investments in warehouses and

equipment.

     For years ending 1980 through 1994, petitioner reported the

following taxable income, before net operating loss deductions or

carryovers:

                      FYE                Income

                     1980                 $52,621
                     1981                  13,169
                     1982                 186,148
                     1983                 228,346
                     1984                 204,601
                     1985                  86,863
                     1986                (680,868)
                     1987                (908,015)
                     1988                (116,678)
                     1989                (740,114)
                     1990                (308,478)
                     1991              (1,538,326)
                     1992              (1,565,929)
                     1993                (213,587)
                     1994                 411,827

     During the years in issue, petitioner primarily sold

tomatoes, but it also marketed other produce, including

cucumbers, bell peppers, melons, and grapes.      During those years,

petitioner distributed produce for Mexican growers (Canelos

growers) that were related to and controlled by Mr. Canelos.     For

the years in issue, the Canelos growers operated under various

names, including Canelos Hermanos, Frutas y Vegetales Del Valle

(Frutave), Administradora Horticola Del Tamazula (Adhota), and
                                - 5 -


Productora ABC (Productora).3   The parties stipulated that Mr.

Canelos controlled petitioner and the Canelos growers within the

meaning of section 1.482-1(a)(3) through (5), Income Tax Regs.

The Canelos growers have been distributing produce in Mexico for

almost as long as they have been distributing produce in the

United States, and the Canelos growers have established

relationships with Mexican buyers.      They operated out of Mr.

Canelos' main office in Culiacan, Sinaloa, Mexico.      Hereinafter,

we will refer to petitioner and the Canelos growers collectively

as the Canelos group; to Mr. Canelos and his brother Constantino

Canelos Rodriguez (Constantino) collectively as the Canelos

brothers; to the Canelos brothers and members of their families

collectively as the Canelos family; and to the Canelos family and

their related businesses collectively as the Canelos

organization.   The Canelos organization functioned as a

vertically integrated operation with farming, packing, and

trucking operations in Mexico and sales and distribution

operations in the United States.

     For the years in issue, the Canelos growers' produce sales

accounted for 98.76 percent, 99.28 percent, 89.24 percent, and

95.87 percent, respectively, of petitioner's total sales.



     3
      Although the entities under which the Canelos growers
operated changed names during the years in issue, the majority of
the members remained the same.
                                 - 6 -


Petitioner had the following sales and volume activity relating

to the Canelos growers for the years in issue:

           FYE                Sales              Boxes

           1989          $43,037,000           6,209,000
           1990           63,445,000           6,188,000
           1991           29,013,000           3,915,000
           1992           22,755,000           2,099,000


     Petitioner's main selling season ran from November through

mid-May.    It worked solely on commission, and, except for produce

sold through Robling & Cathey, L.A., Inc. (RCLA),4 a company

owned by the Canelos brothers, petitioner did not take title to

the produce it distributed.

     In addition to the Canelos growers' produce, petitioner

distributed produce for independent Mexican growers (otros

growers) not related to or controlled by the Canelos family.    The

otros growers generally were small growers who produced a

different line of produce (e.g., grapes, European cucumbers,

squash, melons) from the main lines of produce handled by the

Canelos group.    None of the otros growers shipped tomatoes.




     4
      RCLA Division functioned as a separate division of
petitioner until petitioner sold the division's assets to RCLA
effective June 30, 1990. RCLA was owned by International Farm
Equipment Distributors, Inc., a Liberian corporation owned
equally by Mr. Canelos and Constantino. Produce sold through
RCLA is not in issue in the instant cases.
                              - 7 -


     During the years in issue, services generally performed by

petitioner on behalf of the growers it represented, both related

and unrelated, included:

          (a) Hiring Mexican customs brokers to arrange for

     border inspections and clearing activities by Mexican

     customs, the DOA, and Mexican trade associations;

          (b) hiring U.S. customs brokers to arrange for

     inspection and clearing activities on the U.S. side of the

     border;

          (c) paying border-crossing fees and charges, which then

     were charged directly to the growers' accounts;

          (d) for 1989, 1990, and 1991, paying Mexican labor

     expenses for loading and unloading produce to be inspected

     on the Mexican side of the border, which were not charged to

     the growers;

          (e) paying Mexican legal expenses incurred with respect

     to border crossings, which were not charged to the growers;

          (f) storing the growers' produce at petitioner's

     distribution warehouses in Nogales, Arizona, and/or San

     Diego, California;

          (g) paying laborers for unloading the produce at the

     warehouses;

          (h) inspecting the produce at the warehouses for

     damage, perishability, and disease;
                              - 8 -


         (i) paying any expenses incurred in repacking the

    produce if the pallets or cartons were torn, broken, or

    crushed when the produce arrived;

         (j) destroying or returning to the grower any produce

    that petitioner found unsatisfactory;

         (k) employing salespeople who negotiated the sales

    terms, including the price to be paid for the produce;

         (l) invoicing the sales;

         (m) arranging with the purchaser shipping schedules of

    the produce from petitioner's warehouses;

         (n) loading sold produce onto the trucks of the

    purchaser;

         (o) collecting from the purchaser the proceeds from the

    produce sales and crediting the growers' accounts when the

    produce was sold;

         (p) performing all duties associated with collecting

    the proceeds from the sales of produce, including filing

    PACA claims with respect to uncollected accounts;

         (q) liquidating the growers' accounts;5

         (r) making final liquidations by disbursing funds from

    a grower's liquidation account at the end of the growing



     5
      A grower liquidation is the payment to the grower of the
difference between the sales price and the charges and costs for
selling the grower's produce.
                               - 9 -


     season or after 30 to 40 days from the date of the last

     sale;

           (s) debiting accounts receivable and crediting sales

     for the full amount of the sale upon a sale of a grower's

     produce to a purchaser (a sale could include produce from

     both related and unrelated growers);

           (t) conducting promotional activities, such as

     designing print advertisements and participating in industry

     trade shows; and

           (u) performing at the grower's expense promotional

     activities involving labels not owned by either petitioner

     or related growers.

In liquidating an account, petitioner subtracted from the sales

proceeds its commission and all expenses and costs due from the

grower.   Petitioner then disbursed the remaining funds to the

grower and gave the grower a "liquidation sheet" (final

settlement statement).

     Additionally, petitioner performed the following services

solely for the Canelos family or for the Canelos growers:

           (a) Making sales proceeds available for offset to the

     Canelos growers' loan accounts or for disbursement to them

     as soon as the sales were made;

           (b) performing personal administrative duties, such as

     paying bills, for Canelos family members;
                               - 10 -


          (c) performing administrative duties for other entities

     owned or controlled by Canelos family members;

          (d) in 1989 and 1990, paying an employee of the Canelos

     brothers or their related entities to coordinate growers,

     not the otros growers, in the Baja California, Mexico,

     region (Baja) and to find additional land owners whose

     produce could be shipped through the Canelos organization's

     packing plant in the Baja.

     Alberto Maldonado Guerra (Mr. Maldonado) served as

petitioner's general manager during the years in issue.     He

reported directly to Mr. Canelos.   Mr. Maldonado oversaw

petitioner's day-to-day operations.     He monitored petitioner's

financial status through daily sales reports, weekly receivables

and payables data, and trial balances.    In addition to his

position as petitioner's general manager, Mr. Maldonado served as

secretary-treasurer of Apollo Produce Distributors (Apollo),

which also was owned by the Canelos brothers.

     Petitioner's head bookkeeper and office manager, Eva Padilla

(Mrs. Padilla), reported directly to Mr. Maldonado.    Mrs. Padilla

also served as vice president and secretary and a member of the

board of directors of RCLA.   In addition, she owned Apache

Produce Distributors, Inc. (Apache), with her husband, Peter

Padilla (Mr. Padilla).   Mr. Padilla served as president of

Apache.
                                - 11 -


     Petitioner had approximately 10 people in its accounting

section.   It contracted with RCLA to perform the sales function.

Relationship With Dole

     In November 1981, the Canelos group began doing business

with Dole Food Co. (Dole),6    Dole, a publicly held company, or

some of its subsidiaries or affiliated companies.    Hereinafter,

Dole and its subsidiaries or affiliated companies collectively

will be referred to as Dole.    The business relationship between

the Canelos group and Dole constituted a joint venture.

     The first agreement between Dole and the Canelos group was a

1-year contract (1981 contract), entitled "Sales Subagency

Agreement", in which petitioner and Standard Fruit and Steamship

Co. (Standard Fruit), a company affiliated with Dole, were the

designated parties.   In the 1981 contract, Standard Fruit agreed

to use its marketing resources to market more effectively in the

United States and Canada tomatoes, cucumbers, and bell peppers

grown by the Canelos growers in the Culiacan district of Mexico.

Standard Fruit would receive a commission of 25 percent of total

profit of each product, computed after subtracting from total

revenue (from sales of the product by Standard Fruit, petitioner,


     6
      Some documents in the record refer to Castle & Cooke, Inc.,
rather than to Dole. Although the exact business relationship is
not explained in the record, it appears that Dole Food Co. was a
division of Castle & Cooke, Inc., for at least some portion of
the years in issue.   For simplicity, we will use the name Dole
throughout.
                               - 12 -


or the Canelos growers) selling costs, freight costs, product

costs, and any Mexican-imputed business taxes assessed on sales

of the product.   Included in selling costs was a commission of 40

cents per box paid to petitioner.   Standard Fruit further agreed

to share in 25 percent of the losses and to advance the working

capital needs of the venture up to $2.5 million.

     In July 1982, petitioner and Produce America, Inc. (Produce

America), a subsidiary of Dole, entered into a 5-year agreement

(1982 contract) entitled "Sales Subagency Agreement".   In the

1982 contract, Produce America agreed to use its marketing

resources to market more effectively in the United States,

Canada, and Europe tomatoes, cucumbers, bell peppers, squash, and

eggplant grown by the Canelos growers in various areas in Mexico.

It received a commission of 50 percent of the total profit of

each product.   Profit was computed after subtracting from total

sales revenue selling costs, freight costs, product costs,

duties, and any Mexican-imputed business taxes assessed on sales

of the product.   Included in selling costs was a commission of 40

cents per box paid to petitioner.   Produce America further agreed

to share in 50 percent of the losses and to advance the working

capital needs of the venture up to an amount mutually agreed upon

by the parties.
                                - 13 -


     The SCP Contract

     As of June 16, 1985, petitioner and Sun Country Produce,

Inc. (SCP), a wholly owned subsidiary of Dole, entered into a 5-

year agreement (SCP contract) entitled "Sales Subagency

Agreement".   The SCP contract superseded the 1982 contract and,

as amended, was in effect during the years in issue.

Hereinafter, we will sometimes refer to the overall business

relationship between the Canelos group and Dole under the SCP

contract as the SCP deal.

     Under the SCP contract, SCP agreed to use its marketing

resources to market more effectively in the United States,

Canada, and certain countries in Europe tomatoes, cucumbers, bell

peppers, squash, eggplant, and any other fresh produce specified

by the parties that was grown by the Canelos growers in various

areas in Mexico.    SCP received a commission generally of 45

percent7 of the total profit on each product.   Profit was


     7
      Sec. 2.01 of the Sales Subagency Agreement dated as of June
16, 1985, provides in pertinent part:

          2.01     Commission

                At the beginning of each growing season,
     G.A.C. and S.C.P. shall mutually agree upon an annual
     profit target for all Products in the Territories.
     Each year during the term of the Agreement, S.C.P.
     shall, as compensation for its services, be paid a
     commission, for any annual period in which the actual
     profit equals or is less than the annual profit target,
     of forty-five percent (45%) of the final season-end
                                                   (continued...)
                               - 14 -


computed after subtracting from total sales revenue selling

costs, freight costs, product costs, import duties, any Mexican

imputed business taxes assessed on sales of the product, and any

exchange rate losses due to either devaluation of the peso or the

currency repatriation requirements of the Mexican Government.

Included in selling costs was a commission of 40 cents per box

paid to petitioner.   The Canelos growers received the remaining

55-percent share of the profits.    SCP further agreed to share in

50 percent of the losses and to advance funds for the working

capital needs of the venture up to an amount mutually agreed upon

by the parties.   Petitioner executed promissory notes with SCP in

which petitioner promised to repay the advances, and Mr. Canelos


     7
     (...continued)
     profit calculation made with respect to the growing and
     marketing of the products during the annual period as
     specified in Section 2.02. For any annual period in
     which the actual annual profit exceeds the annual
     profit target, the following commission shall be paid
     to S.C.P.:
                                     S.C.P. COMMISSION
          AMOUNT OVER ANNUAL       PERCENTAGE ON AMOUNT
            PROFIT TARGET           OVER PROFIT TARGET

         Up to $2,000,000                    40%
         $2,000,001 to $4,000,000            35%
         $4,000,001 and Over                 30%

          Should G.A.C. and S.C.P. be unable to reach
     agreement, as to the annual profit target for any
     annual period during the term of this Agreement, the
     parties hereby agree that the annual profit target for
     such annual period shall be the lower of the previous
     annual period's budget projections or actual financial
     results as shown on the financial statements.
                               - 15 -


guaranteed them individually and as petitioner's president.   SCP

gave the Canelos group the right to use the Dole trademark in

connection with the distribution and sale of the products.    In

addition, the Canelos brothers gave SCP a nontransferable,

nonexclusive license to use their ABC trademark8 in connection

with the distribution and sale of products for the duration of

the contract.9

     Petitioner agreed to arrange for consignment to SCP, for

sale pursuant to the SCP contract, a minimum of 25 percent of the

total aggregate production by the Canelos growers.   Petitioner

also agreed to be responsible for invoicing all sales arranged

for or by SCP.   Under the SCP contract, petitioner did not share

in the net profits or losses of the joint venture, and its only

compensation was its commission.

     SCP separately paid for and provided additional marketing

support to petitioner, including the following additional

services to petitioner:   Employing one or two SCP salesmen to

work at petitioner's offices and help sell petitioner's produce;



     8
      Although Mr. Canelos' father established and registered the
ABC label in Culiacan, Mexico, petitioner registered the ABC
label in the United States under petitioner's name when the
Canelos group began dealing with Dole.
     9
      The SCP contract allowed petitioner to use the Dole label
and Dole to use the ABC label without specific charge. The
benefit of usage of those labels was included in the commission
rates charged.
                               - 16 -


providing National Trade Association advertising; providing

booths at industry trade shows; and promoting petitioner's ABC

label through association and advertising with Dole.

      No written contract authorized petitioner to represent the

Canelos growers in negotiations with SCP or to enter into the SCP

contract.   Although, in form, the SCP contract designated

petitioner and SCP as the parties to the contract, the SCP

contract stated, among other things, that both Mr. Canelos and

Constantino, individually and on behalf of the Canelos growers,

intervened in the agreement and agreed "to perform and be bound

by all obligations, undertakings and duties incurred in the above

Agreement by or as 'the Growers'."10

     In 1988, by oral agreement, the Canelos group and SCP raised

petitioner's commission rate under the SCP contract according to

a formula that, in practice, gave petitioner a commission rate of




     10
      By amendment dated as of Nov. 1, 1989, Frutave also
"[intervened]" in the SCP contract and agreed "to perform and be
bound by all obligations, undertakings and duties incurred in the
Agreement by or as 'the Growers'."
                                   - 17 -


55 cents per box during the years in issue.11      Petitioner's per-

box commission rate was not affected by produce price

fluctuations.

     In 1992, petitioner received a commission of 12 percent of

gross sales for produce distributed for Productora in the Baja

under the SCP contract.

     In negotiating the SCP contract on behalf of petitioner, Mr.

Maldonado reviewed petitioner's general accounting and production

records and considered petitioner's fixed costs, its costs per

box, the number of packs petitioner had sold in previous years,

its previous years' income, and the available projections.

     Dole's representatives prepared budgets and projections for

the SCP deal from data, including information on volume and

production, supplied by Mr. Canelos's farming operations.      SCP

incorporated the data into budget books which gave annual and

historical data on the SCP deal.      The Canelos brothers and Mr.

Maldonado reviewed the data in the budget books for 1983 through

1993.    The Canelos brothers, Mr. Maldonado, and representatives


        11
      By oral agreement, the commission rate was amended
commencing with the 1988-89 growing season as follows:

             Number of boxes            Commission per box

        14,000,000 or greater               $.35
        12,000,000 to 13,999,999             .40
        10,000,000 to 11,999,999             .45
        8,000,000 to 9,999,999               .50
        Less than 8,000,000                  .55
                                - 18 -


of Dole each agreed to the closing yearly summary sheets for the

years 1985 to 1992 showing overall profits or losses for SCP, the

Canelos growers, and petitioner.

     Mr. Maldonado and petitioner's other employees provided

information to SCP and Mr. Canelos regarding petitioner's day-to-

day distribution function under the SCP contract.   SCP's

employees and representatives in Mexico obtained information

directly from the Canelos growers regarding their day-to-day

farming operations under the SCP contract.   At the end of each

growing season between 1989 and 1992, Mr. Maldonado reviewed data

on petitioner's losses, and he provided Mr. Canelos with that

data, thereby making Mr. Canelos aware that petitioner was losing

money under the SCP contract.

     Petitioner commingled funds advanced by SCP, received from

produce sales, and lent by commercial banks, thereby making it

impossible to trace funds from SCP to a specific grower.

Petitioner's records do not show advances, including working

capital and liquidation advances, to specific growers.

     Dole generally used a per box commission rate for its

distribution operations.   Dole's normal commission charge during

the years in issue was 55 cents per box.   All of petitioner's

contracts with Dole provided for a commission rate on the basis

of boxes of produce.   Although some of petitioner's competitors
                                - 19 -


charged commissions on a per-box basis, most of them charged on

the basis of a percentage of sales.

     Petitioner was included in the SCP deal because Dole wanted

a U.S. company to be involved in the transaction.        No written

contracts exist authorizing petitioner to represent the Canelos

growers in negotiations with SCP or to enter into the SCP

contract.    In the negotiations with Dole, Mr. Canelos and Mr.

Maldonado negotiated on behalf of petitioner.     The Canelos

brothers negotiated on behalf of the Canelos growers.        Mr.

Canelos had overall authority over the negotiations with Dole on

behalf of petitioner and the Canelos growers.

     For year ending 1986, Dole estimated that the Canelos

growers would export approximately 7 million boxes of tomatoes,

in addition to approximately 3 million boxes of other produce.

For the years in issue, the number of boxes of produce Dole

estimated that petitioner would sell for the Canelos growers, and

the number of packs actually sold, were as follows:

            FYE            Budgeted               Sold

            1989          16,000,000            6,209,080
            1990          19,000,000            6,188,221
            1991          22,000,000            3,915,244
            1992          25,000,000            2,794,408


For years ending before 1985, petitioner never sold more than

6,104,000 boxes of produce.    During the year ending 1985,

petitioner sold 7,526,000 boxes.      For years ending after 1986,
                                - 20 -


petitioner never sold more than the number of boxes sold in the

year ending 1985.

     The SCP contract began in June 1985, and the first sales

under the contract were reported on petitioner's tax return for

the year ending 1986.    Petitioner showed losses on its tax

returns for all the years beginning with and following year

ending 1986.

     The SCP contract provided for an automatic 5-year extension

absent notice of revocation given 1 year before its June 15,

1990, expiration date.   In 1990, the SCP contract was extended

automatically for 5 years when petitioner did not give SCP a

notice of cancellation by June 16, 1989.

     The Canelos growers did not pay U.S. income taxes on their

share of the profits earned under the SCP contract.

     Petitioner, the Canelos growers, and SCP terminated the SCP

deal and extinguished all their obligations and business

relationships under the SCP contract effective May 14, 1993.    As

part of the termination agreement and settlement of accounts

between the Canelos group and SCP, the Canelos brothers and their

related entities repaid advances SCP had made to petitioner.

The Canelos Organization

     During the years in issue, the Canelos brothers used Canelos

Hermanos, an unincorporated business association, as the name of

the farming operations they jointly owned and operated.    Canelos
                                - 21 -


Hermanos also did business as Empaque ABC, which referred to the

Canelos Baja produce and a Canelos farm's packing shed in the

Baja.    Petitioner owned the ABC label and sold Canelos growers'

No. 1 grade produce under that label, as well as under the Dole

label.

     Canelos Hermanos was the only Mexican grower, except for the

otros growers, which shipped produce through petitioner from July

1, 1988, through August 7, 1989.   Canelos Hermanos represented

the Canelos farming operations with respect to Dole, SCP, and

petitioner until 1989, when Frutave was formed and Canelos

Hermanos no longer was used.

     Mr. Canelos was chairman of the board of directors for

Frutave from its incorporation on March 8, 1989, through 1992.

Between August 8, 1989, and September 23, 1990, Frutave was the

Canelos entity through which the Canelos growers operated under

the SCP contract.   Frutave was the only Mexican grower, except

for the otros growers, which shipped produce through petitioner

from August 8, 1989, through September 23, 1990.   On November 1,

1989, Frutave agreed to be bound by the obligations,

undertakings, and duties of the Canelos growers in the SCP

contract and guaranteed petitioner's promissory notes entered

into with SCP.

     Mr. Canelos was the chairman of the board of directors of

Adhota from its incorporation on September 24, 1990, through
                                 - 22 -


1992.   Adhota shipped produce through petitioner from September

24, 1990, through the time of trial.      From September 24, 1990,

Adhota was the Canelos entity through which the Canelos growers

operated under the SCP contract.

     Mr. Canelos was the general director of Productora from its

incorporation on March 7, 1991, through 1992.     Productora shipped

produce through petitioner from March 7, 1991, through June 30,

1992.   Productora bought the produce it distributed through

petitioner from several farms.

     During the years in issue, the Canelos family owned and

controlled packing sheds in Mexico in Culiacan, Nio, and the

Baja.   The managers at the packing sheds reported to Constantino

and other members of the Canelos farming operations.     With the

exception of the otros growers' produce, all Mexican produce

distributed through petitioner came through those packing sheds.

Canelos Hermanos, Frutave, Adhota, and Productora coordinated the

distribution of the produce shipped through petitioner from the

time that it left the packing shed until the time that the

proceeds from the sale of the produce were returned to them.      The

majority of the produce sold under the SCP contract came from the

Canelos family's Mexican packing houses.

     Mr. Canelos was president of Transportes de Carga y Express

(Transportes) during the years in issue.     Transportes, a trucking

company, transported the Canelos produce distributed through
                               - 23 -


petitioner and Apache from Mexico to petitioner's and Apache's

warehouses in Nogales, Arizona.   Most of the produce sold under

the SCP contract was transported by Transportes.

     During the years in issue, Mr. Canelos owned and operated

SUNCO and Alcon, Inc. (Alcon), two Liberian corporations.       SUNCO

handled the loading and unloading of petitioner's produce on the

Mexican side of the border.   Alcon paid a portion of petitioner's

promissory notes for advances from SCP under the SCP contract.

     The Canelos brothers owned and controlled Apollo.     Apollo

did not sell or distribute produce for the Canelos growers.

Apollo purchased cartons, seed, and various farming chemicals and

resold them to the Canelos growers.     Apollo also purchased

cartons for petitioner's other growers.     In addition, during the

years in issue, Apollo rented warehouse space to petitioner in

California and to Apache and Bud Antle, Inc. (Bud Antle), a

wholly owned subsidiary of Dole, in petitioner's complex in

Nogales, Arizona.   Apollo gave Apache the lowest rental rate

Apache could find for the warehouse it rented from Apollo.

     Apollo and petitioner for years ending 1989 and 1990, and

Apollo, petitioner, and RCLA for years ending 1991 and 1992,

constituted a controlled group within the meaning of section

1563.

     In his negotiations with Dole, Mr. Canelos attempted to

reach an agreement that in the whole benefited his produce-
                                - 24 -


related businesses, including, but not limited to, petitioner,

the Canelos growers, Transportes, Empaque ABC, and SUNCO.

Potential Comparable Transactions

     The Otros Growers

     Petitioner distributed grapes, European cucumbers, squash,

and melons for the otros growers.   During the years in issue,

produce from the otros growers that petitioner distributed did

not include tomatoes.    Petitioner charged them a commission rate

of the greater of 55 cents per box or 10 percent of sales for

services including border crossing, loading and unloading,

warehousing, marketing, collecting of sales proceeds, liquidating

the accounts, and distributing the sales proceeds.   Petitioner

retained 55 cents per box of the commission fees collected and

gave any remaining portion of the fees to the Canelos growers.

Petitioner also provided technical assistance and advances for

seed, boxes, freight, customs brokerage expenses, and other

expenses for which the otros growers reimbursed petitioner.

     During the years in issue, petitioner sometimes made money

advances, described as "adelantes" on petitioner's books, to the

otros growers.   The funds for the adelantes sometimes came from

funds that SCP lent to petitioner for advances for the SCP deal.

Petitioner generally made final liquidations to and paid all

otros growers 30 to 40 days after the final sale of their

produce.
                                 - 25 -


     Petitioner was the only entity within the Canelos

organization that provided marketing or distributing services for

the otros growers.    The Canelos growers did not provide any free

services or supplies to the otros growers, such as free cartons,

seed, picking, packing, transportation, or loading or unloading

of trucks, except for technical assistance and other

miscellaneous items provided to grape growers in 1992.     The

Canelos growers had no contracts with the otros growers.     The

otros growers did not report to Mr. Canelos.     They did not share

in the split of profits between the Canelos growers and SCP under

the SCP contract, and they received none of the proceeds from the

Canelos growers.    Neither Mr. Canelos nor Constantino had any

authority to represent the otros growers, and they did not

perform any service for them.    No joint venture agreement existed

between the otros growers and petitioner or SCP.     The otros

growers were not a part of the SCP contract.

     Apache

     Apache began operating in 1986.      From 1987 through the time

of trial, it sold and distributed the Canelos growers' No. 2

grade tomatoes.    Apache sold in different produce markets than

the markets petitioner used to sell the Canelos growers No. 1

tomatoes.     Generally, No. 2 tomatoes sold at a lower price than

No. 1 tomatoes.    The agreement between Apache and the Canelos

growers relating to Apache's sales of the Canelos growers' No. 2
                                - 26 -


tomatoes in the SCP deal was not in writing.    SCP received the

same profit or loss split whether petitioner or Apache sold the

Canelos growers' produce.

     For the years 1988 through 1992, the Canelos growers'

business represented between 70 and 90 percent of Apache's sales.

Apache performed the same major distribution functions for the

Canelos growers that petitioner performed for them.    Apache did

not provide financing for the Canelos growers.    Apache used

SUNCO's facility for crossing the border and paid SUNCO directly

for that use.    Apache did not advance money, seed, or boxes to

its customers.   Unlike petitioner, Apache purchased substantial

amounts of produce and resold it in the years in issue.

Petitioner handled the liquidation and transfer of funds to the

Canelos growers for Apache.    Apache occasionally used the Canelos

growers' Mexican loading facilities.

     In general, Apache charged the Canelos growers a commission

rate of 5 percent of gross sales and a handling charge of 15

cents per box.   In addition to the handling charge of 15 cents

per box, Apache's commission rate for its other customers varied

between 7 and 12 percent, depending on the services rendered.

     Apache put the proceeds from the Canelos growers' sales in

Apache's bank account.   It kept those proceeds until petitioner

or Mr. Canelos asked for the funds to be transferred to

petitioner or distributed to Mr. Canelos.    Those transfers
                                 - 27 -


frequently were made several months after the Mexican produce

growing season ending in April or May.    For the years 1989

through 1992, Apache transferred sales proceeds from the Canelos

growers' produce in the amounts of $11,651,670 to petitioner's

account and $15,000 to the bank account of Mr. Canelos' wife.

     On its Federal corporate income tax returns for years ending

August 31, 1989, through 1992, Apache reported gross receipts of

$705,566, $801,037, $756,640, and $270,999; interest income of

$23,102, $89,078, $53,142, and $29,738; cost of goods sold of

$353,850, $363,345, $228,847, and $11,281; and taxable income

(loss) of $99,084, $78,104, $101,246, and ($278,837).

     Mr. Padilla was Apache's primary salesman, and Apache had

fewer employees than petitioner.    Apache's fixed costs were lower

than petitioner's fixed costs.    Mr. Maldonado, on behalf of Mr.

Canelos and the Canelos growers, and Mr. Padilla, on behalf of

Apache, determined the commission rate that Apache would receive

for selling the Canelos growers' produce.    Mr. Maldonado had no

selling, marketing, or operational responsibilities for Apache.

     Bud Antle

     Beginning in 1986 and continuing through a portion of 1989,

Bud Antle distributed celery, brussels sprouts, and,

subsequently, lettuce for the Canelos growers as part of the SCP

deal.   Initially, Bud Antle received a commission of 10 percent

of sales, one-half of which was absorbed by SCP.    Petitioner
                                - 28 -


received a commission of 40 cents per box from the proceeds of

the produce sold for the services it performed in distributing

brussels sprouts, celery, and lettuce for Bud Antle.

     In November 1988, Bud Antle formally became a party to the

SCP contract through a document entitled "Second Amendment to

Sales Subagency Agreement" (Bud Antle amendment), wherein from

November 1, 1988, to June 1, 1989, petitioner appointed Bud Antle

as its subagent relating to the marketing and sale of lettuce,

celery, and brussels sprouts grown by the Canelos growers in

Mexico.   Under the Bud Antle amendment, the term "SCP" was

defined to include Bud Antle.   SCP and Bud Antle shared in the

profits from the sale of the produce covered under the SCP

contract, as amended.   In addition, petitioner's commission of 40

cents per box was eliminated with respect to the produce sold by

Bud Antle; instead, Bud Antle received a commission of 34 cents

per box as compensation for services in distributing the lettuce,

celery, and brussels sprouts.   Petitioner, nonetheless, received

a commission of 20 cents per pack for border crossing and related

services relating to the Canelos growers' produce that Bud Antle

distributed for them.   In operation, Bud Antle did not receive

its commission as a direct payment.      Rather, Dole made an

internal allocation on its books and records to account for the

commission.   SCP advanced financing to the Canelos growers for

the produce included under the Bud Antle amendment.      Bud Antle
                               - 29 -


took full legal and beneficial title to the produce in Mexico

after its harvest.   William Heintz (Mr. Heintz)12 negotiated the

Bud Antle amendment on behalf of SCP and Bud Antle, and Mr.

Canelos negotiated on behalf of petitioner.

     On November 1, 1989, Bud Antle entered into an agreement

with the Canelos growers and the Canelos brothers entitled the

"Custom Farming and Crop Purchase Agreement" (Bud Antle Purchase

Agreement).   The term of the Bud Antle Purchase Agreement was

November 1, 1989, through June 1, 1990.   The Canelos brothers

negotiated the terms of the Bud Antle Purchase Agreement on

behalf of Frutave and themselves, and Mr. Heintz negotiated on

behalf of Bud Antle.   Under the Bud Antle Purchase Agreement, Bud

Antle purchased and took full legal and beneficial title to

lettuce, celery, and brussels sprouts grown by the Canelos

growers in Mexico once the produce was harvested.   As owner, Bud

Antle sold the crops and collected the sales proceeds.   Bud Antle

reimbursed the Canelos growers for their estimated growing costs

and then paid to the Canelos growers 55 percent of the net sales

proceeds.13   Bud Antle and the Canelos growers shared losses


     12
      William Heintz served as vice president and general
manager of SCP in 1983 and 1984 and as its president from 1985
through 1992. In addition, he served as president of Bud Antle
in 1984 and a portion of 1985, after which he served as president
of Dole Fresh Vegetables.
     13
       Net sales proceeds were computed in part by subtracting
                                                    (continued...)
                               - 30 -


equally.   Bud Antle was responsible for arranging delivery of the

produce.   Petitioner received a commission of 20 cents per box

for its border crossing and some distribution services relating

to the Canelos growers' produce sold by Bud Antle.   The Bud Antle

Purchase Agreement specifically stated that the parties to the

contract operated as independent businesses and did not intend to

create, and were not creating, among other things a partnership

or a joint venture.

     On November 1, 1989, Bud Antle leased a vegetable cold room,

loading docks, a desk, and a telephone located in Nogales,

Arizona, from Apollo.

     Bud Antle also distributed produce in the United States for

growers not related to the Caneloses.   For its services for the

unrelated growers, Bud Antle negotiated an overall pack charge

for harvesting labor and equipment, cartons, selling,

transportation, marketing, inventorying, warehousing, and

collecting sales proceeds but which did not include any charges

for customs, loading and unloading at the border, nor warehousing

at the border.   Bud Antle did not break down a commission rate in

negotiating the overall pack charge, but for internal accounting



     13
      (...continued)
from sales proceeds the growing costs, transportation costs,
petitioner's commission of 20 cents per box, and an allocation
for Bud Antle's marketing charges (calculated at $35,000 a year
plus 34 cents per box sold by Bud Antle).
                               - 31 -


purposes, Bud Antle allocated a commission of 55 cents per

package for its services.   In addition to the pack charge, Bud

Antle received a share of the profits from the domestic sales.

Bud Antle did not perform any border-crossing activities for its

domestic growers and took title to the produce grown by the

domestic growers.

     Bud Antle distributed the Canelos growers' lettuce, brussels

sprouts, and celery produce from 1986 through 1991.

     Van Dyke

     In March 1988, petitioner entered into a marketing agreement

(Van Dyke contract) with Van Dyke Farms (Van Dyke), an unrelated

California grower.   Pursuant to the Van Dyke contract, petitioner

agreed to market mix-melons for Van Dyke from May 1 through

December 31, 1988, for a marketing commission of 8 percent of the

selling price F.O.B. shipping point (Van Dyke deal).   In

addition, Van Dyke reimbursed petitioner for the services of

David Rojas, one of petitioner's employees.   Consequently, Van

Dyke, in effect, paid a commission rate of 9.5 percent of sales,

which for the Van Dyke deal was the equivalent of a commission

rate of 56 cents per box.   Petitioner performed no services for

Van Dyke other than marketing activities and loading and

unloading services, for which Van Dyke reimbursed petitioner.

Van Dyke handled the warehousing and transporting of the melons.
                               - 32 -


The Van Dyke contract did not involve border-crossing activities

because Van Dyke was located in the United States.

     Fresh Choice

     Fresh Choice Produce, Inc. (Fresh Choice), a California

corporation, was a distributor of green onions.   In February

1992, Fresh Choice entered into a commission merchant agreement

(agreement) with Manuel Valladolid Seamanduras, on his own behalf

and as representative of Agro Industrias Vigor S.R.L. de C.V.

(Agro), a Mexican corporation, and Vessey & Co. (Vessey), a

California corporation, in which each party agreed to share in

the profits from the sale of green onions14 grown by Agro in

Mexico and marketed by Fresh Choice internationally (joint

venture).   Fresh Choice's and Vassey's principal places of

business were in the State of California.

     Fresh Choice received a 25-percent share of the profits of

the joint venture, Agro received a 50-percent share, and Vessey

received a 25-percent share.   Profits were calculated net of

expenses paid by Fresh Choice on behalf of the joint venture and

of Fresh Choice's commission, which was computed as follows:




     14
      Although the agreement on its face is limited to green
onions grown by Agros and sold by Fresh Choice, it appears that
the sale of brussels sprouts and snow peas also was included in
the joint venture.
                                - 33 -


                F.O.B. Price
                  per unit               Commission

                 $0   - $3.99              $.25
                  4   - 5.99                .35
                  6   - 7.99                .45
                  8   and up                .55

Agro was responsible for all costs associated with growing,

harvesting, packing, and delivering the green onions to Fresh

Choice.

     In the agreement, Fresh Choice agreed to perform all the

work of transporting, receiving, storing, loading, distributing,

and selling the green onions grown by Agro, to collect the sales

proceeds, and to provide technical assistance.    It served as

importer of record of the green onions.

     Fresh Choice also agreed to advance working capital funds,

and, for that purpose, it provided a line of credit to Agro for

which it received interest on loans against that line of credit.

Vessey also provided financing for the joint venture.

Audit Determination

     On audit, respondent determined that the 55-cent-per-box

commission rate petitioner received from the Canelos growers did

not constitute an arm's-length charge.    Consequently, respondent

increased petitioner's income for commissions from the Canelos

growers by the following amounts:
                                - 34 -


                  Commission                   Commission
                  income per                    income as
      FYE          return        Increase       adjusted

    6/30/89      $3,212,829     $3,120,433     $6,333,262
    6/30/90       3,186,941      3,125,044      6,311,985
    6/30/91       2,184,932      3,178,952      5,363,884
    6/30/92       1,511,017      3,179,676      4,690,693


Respondent calculated the increased commission on the basis of

petitioner's operating costs plus 54 percent of those costs.

                               OPINION

In General

     Section 48215 gives the Commissioner broad authority to

allocate income, deductions, credits, or allowances between



     15
       Sec. 482 provides:

                  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 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. In the case of any transfer (or
             license) of intangible property (within the
             meaning of section 936(h)(3)(B)), the income with
             respect to such transfer or license shall be
             commensurate with the income attributable to the
             intangible.
                                - 35 -


commonly controlled organizations, trades, or businesses if the

Commissioner determines that the allocation is necessary to

prevent the evasion of taxes or clearly to reflect the income of

the controlled entities.   The purpose of section 482 is to

prevent the artificial shifting of the net incomes of controlled

taxpayers by placing controlled taxpayers on a parity with

uncontrolled, unrelated taxpayers.   See Seagate Tech., Inc. &

Consol. Subs. v. Commissioner, 102 T.C. 149, 163 (1994);

Sundstrand Corp. & Subs. v. Commissioner, 96 T.C. 226, 352-353

(1991); Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525, 581

(1989), affd. 933 F.2d 1084 (2d Cir. 1991); Edwards v.

Commissioner, 67 T.C. 224, 230 (1976); sec. 1.482-1(b)(1), Income

Tax Regs.   The Commissioner may make allocations under section

482 even in the absence of tax avoidance motives in order clearly

to reflect the respective incomes of members of the controlled

group.   See Central Cuba Sugar Co. v. Commissioner, 198 F.2d 214,

215-216 (2d Cir. 1952), affg. in part and revg. in part 16 T.C.

882 (1951).   Thus, establishment of a business purpose for a

transaction does not necessarily insulate the taxpayer from a

section 482 allocation.    See Bausch & Lomb, Inc. v. Commissioner,

supra at 582.

     The parties have stipulated that Mr. Canelos controlled

petitioner and the Canelos growers within the meaning of section

1.482-1(a)(3) through (5), Income Tax Regs.   Accordingly, a
                                - 36 -


reallocation of income between petitioner and the Canelos growers

is appropriate if the compensation paid to petitioner relating to

its services for the related entities does not clearly reflect

the true taxable income of the members of the controlled group.

See Commissioner v. First Sec. Bank, N.A., 405 U.S. 394, 400

(1972); Hospital Corp. of Am. v. Commissioner, 81 T.C. 520, 594

(1983).

     The regulations set forth an arm's-length standard to

determine whether reallocations between controlled entities are

needed.   Thus, the regulations attempt to identify the "true

taxable income" of each entity on the basis of the taxable income

which would have resulted had the entities been uncontrolled

parties dealing at arm's length.   See sec. 1.482-1(b)(1), Income

Tax Regs.

     Respondent's determination as set forth in the notice of

deficiency is presumptively correct, and petitioner bears the

burden of disproving that determination.   See Rule 142(a); Welch

v. Helvering, 290 U.S. 111 (1933).   Moreover, respondent's

section 482 determination must be sustained absent a showing that

he has abused his discretion.   See Paccar, Inc. & Subs. v.

Commissioner, 85 T.C. 754, 787 (1985), affd. 849 F.2d 393 (9th

Cir. 1988).   To succeed, therefore, petitioner first must show

that respondent's section 482 allocations are arbitrary,

capricious, or unreasonable.    See G.D. Searle & Co. v.
                               - 37 -


Commissioner, 88 T.C. 252, 359 (1987).   Whether respondent has

exceeded his discretion is a question of fact.   See American

Terrazzo Strip Co. v. Commissioner, 56 T.C. 961, 971 (1971).      In

reviewing the reasonableness of respondent's determination, the

Court focuses on the reasonableness of the result, not on the

details of the methodology used.    See Bausch & Lomb, Inc. v.

Commissioner, supra at 582; Eli Lilly & Co. v. United States, 178

Ct. Cl. 666, 676, 372 F.2d 990, 997 (1967).

     Should the taxpayer overcome the Commissioner's presumption

of correctness and prove that the deficiencies set forth in the

notice of deficiency are arbitrary, capricious, or unreasonable,

but fail to prove that alternative allocations it proposes

satisfy the arm's-length standard, the Court must determine from

the record the proper allocation of income between or among the

controlled entities.   See, e.g., Sundstrand Corp. & Subs. v.

Commissioner, supra at 354; American Terrazzo Strip Co. v.

Commissioner, supra; Nat Harrison Associates, Inc. v.

Commissioner, 42 T.C. 601 (1964).

     In the notices of deficiency, respondent calculated that

petitioner's commission income in total for the years in issue

should be increased from $10,095,719 to $22,699,824, an increase

of $12,604,105.   Respondent now has adopted Dr. Daniel J.

Frisch's (Dr. Frisch) opinion that petitioner's commission income
                                - 38 -


in total for the years in issue should be increased to

$17,125,719, an increase of $7,030,000.

     The deficiencies respondent adopted at trial are

substantially lower than the amounts respondent determined and

are based on a different methodology from the method used to

calculate the notice amounts.   Accordingly, generally petitioner

would need prove only that the commission it charged in the SCP

deal satisfied the arm's-length standard.    See National

Semiconductor Corp. & Consol. Subs. v. Commissioner, T.C. Memo.

1994-195.   Petitioner, however, contends that respondent's change

in method of calculating the deficiency, from a cost-plus

methodolgy to a comparable pricing methodology, raises new matter

for which respondent bears the burden of proof.    We need not

decide in this case whether respondent's use of a different

method for calculating the deficiencies raises new matter

because, as discussed infra, the preponderance of the evidence

favors respondent.

Services Regulations

     Section 1.482-2(b), Income Tax Regs., applies to

transactions in which one related entity provides marketing,

managerial, administrative, technical, or other services for

another related entity for less than an arm's-length charge.     See

sec. 1.482-2(b)(1), Income Tax Regs.     An arm's-length charge is

defined as the "amount which was charged or would have been
                               - 39 -


charged for the same or similar services in independent

transactions with or between unrelated parties under similar

circumstances considering all relevant facts."   Sec. 1.482-

2(b)(3), Income Tax Regs.   Unless the services are an integral

part of the business activity of either the entity rendering the

services or the entity receiving them, the arm's-length charge is

deemed to be equal to all the costs or deductions incurred which

are directly or indirectly related to the services performed.

The taxpayer, however, may establish a more appropriate charge.

See sec. 1.482-2(b)(3) and (4), Income Tax Regs.   The costs or

deductions incurred in rendering the services, however, are not

deemed equal to the arm's-length charge for services which are an

integral part of the business activity of either the member

rendering the services or the member receiving the benefit of the

services.   See sec. 1.482-2(b)(7), Income Tax Regs.

     Services are considered an integral part of the business

activity of a member of a group of controlled entities if:     (i)

Either the renderer or the recipient is engaged in the trade or

business of rendering similar services to one or more unrelated

parties; (ii) the renderer renders services to one or more

related parties as one of its principal activities; (iii) the

renderer is peculiarly capable of rendering the services and such

services are a principal element in the operations of the

recipient; or (iv) the recipient has received the benefit of a
                               - 40 -


substantial amount of services from one or more related parties

during its taxable year.   See id.

     During the years in issue, petitioner rendered marketing

services to the unrelated otros growers similar to the marketing

services it rendered on behalf of the related Canelos growers;

therefore, the services petitioner rendered on behalf of the

Canelos growers are considered an integral part of petitioner's

business activity.   Sec. 1.482-2(b)(7)(i), Income Tax Regs.

Consequently, an arm's-length charge for the marketing services

rendered by petitioner relating to the SCP deal would be an

amount that petitioner charged or would have charged an unrelated

party for the same or similar services in an independent

transaction under similar circumstances, considering all relevant

facts.   Sec. 1.482-2(b)(3), Income Tax Regs.

     Petitioner contends that the commission rate it charged in

the SCP deal constituted an arm's-length rate.   Respondent

contends, however, that a party dealing at arm's length on behalf

of petitioner would not have accepted the SCP deal.

Expert Testimony

     In support of their respective positions, each party has

submitted the testimony of an expert witness or expert witnesses

relating to what constitutes an arm's-length charge for the

services petitioner rendered on behalf of the SCP deal.
                               - 41 -


     Petitioner's Expert Witness

     Petitioner submitted the expert report of Dr. Roberta Cook

(Dr. Cook).   She has a Ph.D. in agricultural economics and is

employed as an extension economist in the Department of

Agricultural Economics at the University of California-Davis.

Dr. Cook's major area of specialization is fresh fruit and

vegetable marketing.   She also works in the broad area of food

distribution.   Dr. Cook concluded that, taking into consideration

the nature and volume of the products, as well as the functions

performed and the risks assumed in petitioner's operations,

petitioner was charging its related growers a commission rate

consistent with industry standards and in accordance with section

1.482-2(b)(3), Income Tax Regs.

     In assessing the arm's-length nature of petitioner's

commission rate, Dr. Cook considered:   (1) Produce distribution

industry standards; (2) distribution agreements between

petitioner and unrelated parties, particularly SCP, but also Bud

Antle, Apache, Van Dyke, and the otros growers; (3) comparable

agreements between other unrelated parties (specifically Fresh

Choice); (4) the nature of the products being distributed; (5)

the volume of products being sold; (6) the types of functions and

services performed; and (7) the risks assumed by the parties to

the agreements.   Dr. Cook stated that the SCP contract was a

third-party growing/marketing agreement between SCP, petitioner,
                                - 42 -


and the Canelos growers.   Dr. Cook concluded that comparable

produce distribution agreements between unrelated parties

provided the most reliable basis for establishing an arm's-length

commission for petitioner.    According to Dr. Cook, taken as a

whole, the third-party agreements and other industry agreements

which she considered provided substantiation for the arm's-length

nature of the commissions petitioner earned during the years in

issue.

     Dr. Cook stated that when petitioner entered into the SCP

contract with Dole, petitioner agreed to a commission rate that

was favorable given the large volumes that were expected to

materialize.    According to Dr. Cook, in the low-margin food

industry, firms make their profits on volume.    Dr. Cook asserted

that commission rates are typically higher when distributors

provide growers with advances to fund capital needs for planting,

harvesting, packing, and transportation.    Dr. Cook noted that for

the years in issue SCP, not petitioner, advanced funds to the

Canelos growers.

     According to Dr. Cook, for Nogales distributors of Mexican

(dominated by Sinaloan) fresh produce, the common range of

commissions was 5 to 12 percent of the gross selling price.     She

asserted that the larger the volumes handled and the fewer the

services provided by the distributor, the lower the commission

rate.    She stated also that the financing of production,
                                 - 43 -


harvesting, and packing costs are the main services that caused

commission rates to be on the high end of the range.     Dr. Cook

further stated that some U.S.-based distributors also offered

extensive technical assistance in the form of production methods

to their Mexican growers, and many had field staff operating in

Mexico.     She asserted that where those costly services were

provided, they were reflected in the commission rates, sometimes

reaching 10 to 12 percent.     According to Dr. Cook, when a

distributor does not provide grower financing, the range is more

likely between 5 and 10 percent; and when production-related

technical assistance is not involved, the range tends to be

between 5 and 8 percent.     She stated further that volume, i.e.,

the overall size of the deal, also significantly affects the

rate.     Dr. Cook stated:

     In this case, it was SCP/Dole that funded advances to
     the Related Growers and thus bore the cost of tying up
     this capital. In addition, the SCP Deal was a large
     volume deal and economies of scale were applicable.
     GAC provided no production technical assistance or
     field personnel; while Dole itself performed part of
     the marketing services, via loaned salesmen and trade
     advertising.18 Given these factors, GAC would not be
     expected to receive a commission at the upper end of
     the industry range. Rather, it is my opinion that
     given the large expected volumes and unique character
     of the SCP Deal, if a percentage commission rate would
     have been utilized, it would likely have been on the
     lower end of the typical range observed in Nogales,
     approximately 6 percent.
     18
      Dole provided one to two salesmen that worked at GAC's
     office in Nogales selling produce for GAC. These salesmen
                                 - 44 -


     were paid by Dole and were effectively loaned to GAC to help
     market SCP Deal produce through Dole connections.

Thus, Dr. Cook concluded that petitioner's commission rate of 55

cents per package was reasonably similar to the rate that would

have been charged by an uncontrolled distributor negotiating with

an uncontrolled grower under similar circumstances.

     Respondent's Expert Witnesses

     Respondent submitted the expert report of Dr. Frisch.    He

has a Ph.D. in economics from Harvard University and is a

managing director at Horst, Frisch, Clowery & Finan, Inc., an

independent economic consulting firm specializing in transfer

pricing and other tax-related matters.    Dr. Frisch's field of

expertise is international tax in general and transfer pricing

specifically.   Dr. Frisch concluded that the commissions

petitioner received from the SCP deal during the years in issue

were not arm's length.

     Dr. Frisch asserted that the fact that petitioner's

commission rate was mentioned in the SCP contract does not imply

that the rate is arm's length.    Dr. Frisch stated that the owners

of the Canelos group were interested in the group's overall

profits from the SCP contract and, therefore, they might have

been willing to accept a below-arm's-length commission rate for

petitioner inasmuch as the Canelos organization as a whole would

receive offsetting benefits from other provisions of the SCP
                               - 45 -


deal.   Therefore, had petitioner been independent, it might not

have been willing to accept the commission rate specified in the

SCP contract.   According to Dr. Frisch, the commission paid to

petitioner was just one piece of the financial arrangement

between Dole and the Canelos group.     He stated:   "While the

arrangement as a whole was clearly arm's length, it is not

possible to tell directly whether any one piece of it, taken in

isolation, was something to which arm's-length parties would

agree."

     Dr. Frisch disagreed with Dr. Cook's opinion that the Van

Dyke, Apache, or Bud Antle transactions were comparable to

petitioner's transactions with the otros growers.      Dr. Frisch

stated that petitioner did not perform the same functions for Van

Dyke as it performed for the Canelos growers or for the otros

growers.   In particular, the Van Dyke transactions did not

involve border-crossing activities, Van Dyke did its own

warehousing, and it arranged for the buyers to pick up the

produce from its facilities.

     As for the Apache transactions, Dr. Frisch stated that those

transactions are not comparable to the SCP deal because the

market for "off-grade" tomatoes handled by Apache was

significantly different from the market for the high-quality

tomatoes distributed by petitioner.     In the "off-grade" market,

the customers consist of buyers who are interested in a value
                               - 46 -


buy, not in the quality of the product.   Thus, Dr. Frisch

concluded, it would be inappropriate to use Apache's transactions

as comparables for petitioner's transactions with the Canelos

growers.

     With respect to Bud Antle, Dr. Frisch asserted that, because

Bud Antle was related to SCP and Dole, the commissions paid to it

for marketing the Canelos growers' celery, lettuce, and brussels

sprouts may have been affected by other aspects of the

relationship between SCP and the Canelos group.   Additionally,

Dr. Frisch also stated that, because petitioner and Bud Antle

shared the commissions, it was not clear that Bud Antle performed

the full range of marketing functions; instead, it may have

merely assisted petitioner.

     Dr. Frisch concluded that the 10-percent commission rate

petitioner charged the otros growers was consistent with the 8-

to 12-percent commission rates U.S. distributors charged for

selling Mexican produce in Nogales, Arizona, and other places as

stated in a study entitled "Competition in the U.S. Fresh

Vegetable Industry", written by John A. VanSickle, Emil

Belibasis, Dan Cantliffe, Gary Thompson, and Norm Oebker, and

published by the U.S. Department of Agriculture, Economic

Research Service, Agricultural Economic Report No. 691 (July

1994).   Dr. Frisch stated that petitioner's commission rate

received from the otros growers was generally in line with
                               - 47 -


industry averages.   He asserted that the commission rate paid by

the otros growers for petitioner's services was simply the 10

percent of sales actually paid by those growers to petitioner.

He believed that the fact that petitioner paid a portion of the

commissions to the Canelos growers does not change that fact.     He

asserted that petitioner would not have made the payment to the

Canelos growers had petitioner been an independent party

operating at arm's length.   Dr. Frisch concluded that the

commission rates paid by the otros growers provide the best

evidence of an arm's-length commission rate for petitioner.

     Dr. Frisch stated that petitioner performed essentially the

same functions for the otros growers as it performed for the

Canelos growers.   He stated that one difference in the

transactions consisted of the quantities involved--over the years

in issue, the otros growers accounted for approximately 3.3

percent of the total produce sold by petitioner, with the Canelos

growers accounting for the rest.   According to Dr. Frisch, the

normal practice for produce distributors was to charge the same

commission to large growers as to small growers.   Thus, he

stated, the fact that the Canelos growers were larger than the

otros growers does not imply that they would pay different

commission rates to an unrelated marketer.   Consequently, Dr.

Frisch concluded that no adjustment to the otros growers'

commission rate was needed for the difference in volume.
                               - 48 -


     According to Dr. Frisch, an adjustment to the otros growers'

commission rate was needed to account for a difference in the way

in which petitioner forwarded the funds it received from the

buyers on behalf of the Canelos growers.    He stated that, for the

otros growers, petitioner generally sent the funds to the growers

approximately 30 days after the date of sale.    However, for the

Canelos growers, SCP lent working capital which petitioner

advanced to the growers; after the sale of the produce,

petitioner immediately credited the net amount, after expenses

and commission, from the growers' outstanding balances instead of

actually sending money.   Thus, Dr. Frisch concluded, the Canelos

growers ended up paying less interest to petitioner than they

would have had petitioner waited approximately 30 days before

giving the growers credit for the sale.    He asserted that

petitioner accordingly enjoyed a 30-day time-value-of-money

advantage with the otros growers that it did not have in its

dealings with the Canelos growers.   Dr. Frisch said that the

Canelos growers would be in an equivalent position if petitioner

charged the Canelos growers the 10-percent rate with the otros

growers' payment terms, or if it charged them an 11-percent rate

with the actual payment terms it used for the Canelos growers.

     Dr. Frisch asserted also that an adjustment to the otros

growers' commission rate was needed to account for a service

petitioner performed for the Canelos growers that it did not
                                 - 49 -


perform for the otros growers.    In 1989 and 1990, petitioner made

payments of $50,000 and $100,000 to Mr. Cecilio Espinosa (Mr.

Espinosa), an employee of the Canelos brothers, or an entity

controlled by them other than petitioner.     Those payments were

related to his activities in managing Canelos growers located in

the Baja.   According to Dr. Frisch, as a marketer, petitioner

would not have made such payments to an employee of an unrelated

group of growers (and did not make such payments to the otros

growers).

     Dr. Frisch stated that the adjustments he made improved the

comparability of the otros growers' commissions and the Canelos

growers' commissions by accounting for the latter two differences

in the transactions between petitioner and the Canelos growers

and petitioner and the otros growers.     He calculated that an

arm's-length commission for petitioner for the years in issue

would have been 94 cents when expressed as a per-package rate, or

11.06 percent when expressed as a percentage of sales.

Accordingly, Dr. Frisch concluded that petitioner's commissions

for the years in issue in total would have been $7,030,000 higher

had petitioner been treated in an arm's-length fashion by the

Canelos growers.   His calculation of the increase in commission

income for each year is as follows:
                                 - 50 -


                     FYE              Amount

                   6/30/89          $1,307,000
                   6/30/90           3,538,000
                   6/30/91           1,153,000
                   6/30/92           1,032,000

                    Total            7,030,000


     Dr. Frisch used a profit-split analysis and a comparison

with industry averages to test the reasonableness of his

conclusions.   He stated that the two reasonableness tests

confirmed that applying the otros growers' commission rate, with

adjustments, to petitioner's related-party transactions would

result in petitioner's earning appropriate levels of income

during 1989 through 1992.     Further, he stated, those tests

indicate that petitioner's income levels as reported on its tax

returns for the years in issue were not consistent with arm's-

length behavior.    Therefore, Dr. Frisch concluded that it was

necessary to adjust petitioner's commissions in order to make

them consistent with the arm's-length standard.

     Respondent also submitted the expert report of Enrique E.

Figueroa (Dr. Figueroa).     He has a Ph.D. in agricultural

economics from the University of California-Davis and is employed

as a research associate for the Department of Agricultural,

Resource and Managerial Economics at Cornell University.      Dr.

Figueroa provided general background information on the produce

industry.
                                 - 51 -


Discussion

     Petitioner contends that the SCP contract is an arm's-length

agreement between two unrelated parties (i.e., petitioner and

SCP) and, therefore, section 482 does not apply in the instant

cases.   On brief, respondent contends, on the other hand, that

the SCP contract represents a complicated arrangement in which

petitioner functioned as a member of a combined group, not as an

independent negotiating party.    The real issue, respondent

asserts in effect, is whether the income petitioner reported on

its U.S. corporate income tax returns for the years in issue

pertaining to the SCP deal constitutes a reasonable allocation of

petitioner's share of the Canelos organization's overall income

from that deal for those years.    The parties have stipulated that

petitioner and the Canelos growers are controlled taxpayers

within the meaning of section 1.482-1(a), Income Tax Regs.

     While, on its face, the SCP contract was between Dole and

petitioner, we are persuaded that, in substance, it was not

merely between those two parties.    Rather, in our view, the SCP

deal, to which the SCP contract related, constituted a joint

venture between Dole on the one hand and the Canelos organization

on the other.   It is clear from the record that Dole considered

petitioner and the Canelos growers to be indivisible components

of the Canelos organization and that it was with the Canelos

organization that Dole agreed to do business.   The commission
                                - 52 -


payable to petitioner was merely one part of the overall earnings

due the Canelos organization relating to the SCP deal.    How the

Canelos organization internally allocated its share of the income

generated by the SCP deal was inconsequential to Dole as long as

Dole received its agreed-upon share of the joint venture's

earnings.    Thus, the question for decision is whether the income

the Canelos growers allocated to petitioner pertaining to the SCP

deal for the years in issue clearly reflected its share of the

combined income of the controlled taxpayers.    Accordingly,

contrary to petitioner's assertion, section 482 does apply in the

instant cases.

       We must decide whether the commission rate paid petitioner

in the SCP deal represents an arm's-length charge for its

services.    If it does not, then we must decide what would be an

arm's-length charge for those services.

       Arm's-Length Commission Rate

       Petitioner contends that Mr. Canelos and Mr. Maldonado

negotiated a fair commission rate for the services petitioner

rendered relating to the SCP deal, considering the expected

volume, industry standards, and the amount SCP was willing to

pay.    Petitioner maintains that it wanted the highest possible

commission it could obtain because the Canelos group kept 100

percent of any commission petitioner received but received only

55 percent of any farming profits.
                               - 53 -


     Respondent contends that petitioner's 55-cent-per-package

commission rate16 was not negotiated at arm's length given that it

did not even cover petitioner's fixed costs.   Respondent contends

that the Canelos group agreed to an unprofitable commission rate

for petitioner because they believed petitioner's losses would be

offset by earnings from the SCP deal of other members of the

Canelos organization.

     Petitioner counters that, although Mr. Canelos was aware

generally of the commission rate that petitioner would need to

break even, he reasonably believed, on the basis of Dole's

projections and the representations it would promote the Canelos

growers' produce and increase sales, that petitioner could make a

profit under the SCP deal.   Petitioner contends that had volume

increased as Dole projected, petitioner's losses would have been

eliminated.



     16
      Petitioner asserts that the 55-cent-per-package commission
rate converts to a rate of 6.6 percent of sales using a weighted
average package price of $8.31 per package over the years 1989
through 1992. Petitioner asserts further that the per-package
rate would convert to a rate of 7.4 percent of sales if the
unusually high 1990 prices were ignored. Respondent disputes the
accuracy of petitioner's percentage-of-sales calculations because
the amounts are calculated on total Canelos growers' proceeds,
not proceeds relating to sales made by petitioner. Respondent
does not indicate what the percentage-of-sales calculations would
be on the basis of corrected sales data. The precise percentage
rate to which the 55-cent-per-package rate would equate is not in
issue in the instant cases. All we need know is that the 55-cent
rate is substantially less than the 10-percent rate that was paid
by the otros growers.
                               - 54 -


     Respondent maintains, however, that by the first year in

issue, it was unrealistic for petitioner to continue to rely on

Dole's projections.   Respondent contends that under similar

circumstances an independent party would have demanded an

increased commission rate before permitting the SCP contract to

renew automatically at the end of its initial 5-year term.

Petitioner, however, did not terminate the SCP contract even

though the commission rate did not cover petitioner's expenses.

     We agree with respondent that a party operating at arm's

length would not have continued in the SCP contract under the

terms of that contract.   We are persuaded that, even before the

years in issue, the Canelos group could not reasonably have

expected to achieve the volume of 10 million boxes projected by

Dole. Petitioner never had a profitable year while the SCP

contract was in effect.   We doubt that an unrelated third party

would have been willing to continue in a similar unprofitable

arrangement.   In our view, from the inception of the SCP deal the

Canelos brothers were not concerned with whether petitioner on

its own realized a profit from the SCP deal but, rather, whether

the Canelos organization as a whole prospered from the

arrangement.   Canelos-owned or controlled entities were involved

in, and compensated for, all phases of the SCP deal including

providing seed, cartons, and chemicals (Apollo), growing and

packing the produce (Canelos Hermanos, Frutave, Adhota, or
                               - 55 -


Productora), loading and unloading it (SUNCO), transporting it

(Transportes), and distributing it (petitioner).   The expenses

related to the operations of those other entities, and we assume

some profit to them, were paid from sales proceeds before

calculating any profit or loss split.

     We are persuaded that had petitioner been an unrelated

party, it would never have agreed to retain the 55-cent-per-

package commission rate for the years in issue.    We conclude that

the 55-cent-per-package commission rate did not constitute an

arm's-length rate.   The question then is what commission rate an

unrelated party would have accepted for its services in the SCP

deal.

     Respondent contends that the otros growers' 10-percent

commission rate serves as the best evidence of an arm's-length

charge for the services petitioner rendered in the SCP deal.    The

otros growers were unrelated customers of petitioner.   Respondent

contends that petitioner's functions for the otros growers were

in all important respects the same functions that petitioner

performed for the Canelos growers.   Respondent maintains that, to

be comparable, the 10-percent commission rate required only two

adjustments to account for two additional services that the

Canelos growers received that the otros growers did not.

Accordingly, respondent contends, for its services in the SCP

deal petitioner should have charged a commission rate of 11.06-
                               - 56 -


percent-of-sales for the years in issue, which equates to a per-

package rate of 94 cents.

     Petitioner denies that the otros growers' commission rate is

the best evidence of an arm's-length charge for the services

petitioner performed in the SCP deal but maintains that the otros

growers' commission rate is only one of several commission rates

(i.e., rates charged by Bud Antle, Fresh Choice, Apache, and Van

Dyke) that must be adjusted before being considered reasonable

comparables.   Petitioner contends that the 11.06-percent-of-sales

commission rate suggested by Dr. Frisch, and adopted by

respondent at trial, is based on flawed methodology and

insupportable assumptions.

     Petitioner agrees that the services it performed for the

otros growers were similar to the services it performed for the

Canelos growers.   Petitioner, however, asserts that it provided

additional services to the otros growers that Dr. Frisch did not

take into account, such as providing technical assistance and

advances in kind (boxes and seeds), as well as providing money

advances.   Petitioner contends further that Dr. Frisch

inappropriately adjusted the otros growers' commission rate

upward to account for a service that Dr. Frisch thought

petitioner provided for the Canelos growers that it did not

provide for the otros growers; i.e., that petitioner made funds

available to the Canelos growers immediately upon the sale of the
                               - 57 -


produce, whereas petitioner delayed making funds available to the

otros growers until 30 days after the sale.   Petitioner

maintains, however, that it credited all growers' accounts

immediately upon sale.   Therefore, petitioner contends, any use

of a float adjustment would be arbitrary and inappropriate.

     Petitioner also contends that Dr. Frisch did not adjust the

otros growers' commission rate to reflect the distinction and

character of the per-box rate structure used for the SCP deal as

contrasted with the percentage of sales fee structure used for

the otros growers' transactions.   Petitioner asserts that Dr.

Frisch used an after-the-fact analysis of a low-volume percentage

commission rate structure to compare to a high-volume per-box

rate structure.

     Petitioner contends that in the produce industry economies

of scale justify volume discounts, and that Dr. Frisch

erroneously failed to adjust the otros growers' commission rate

for volume considerations.

     Petitioner contends also that Dr. Frisch failed to adjust

the otros growers' commission rate to reflect the type of produce

sold by the otros growers that had different handling and

distribution considerations than the fresh tomatoes sold by the

Canelos growers.

     Respondent contends, on the other hand, that in arriving at

her conclusions Dr. Cook did not place importance on:    (1) The
                               - 58 -


relationships to each other of the contracting parties, (2) any

compensation under the contract in addition to the commission,

(3) how the cost structure and financial position of the alleged

comparable compares to petitioner's cost structure and financial

position, and (4) whether the parties to the contract examined

actually performed the same services as did petitioner.

Respondent also contends that there are inaccuracies in Dr.

Cook's calculations.

     Respondent contends that Bud Antle's arrangements with the

Canelos growers and with its domestic growers varied

significantly from petitioner's arrangement under the SCP deal

and, therefore, the Bud Antle commission rate cannot serve as a

reliable comparable in determining petitioner's arm's-length

commission rate.   Respondent asserts that Bud Antle received a

share of the profits under its arrangements or received

compensation in addition to its commission; it operated as part

of Dole, making its transactions with SCP related-party

transactions; and it did not perform any border-crossing

services.   Petitioner counters that the Bud Antle amendment is a

reliable comparable for petitioner's commissions relating to the

SCP deal.   Petitioner maintains that the 34-cent-per-package

commission was independent of the profit split and that the

commission was paid for Bud Antle's selling services.   According

to petitioner, Bud Antle received its share of the profits, not
                               - 59 -


directly through the Bud Antle amendment, but indirectly through

SCP because Bud Antle's farming operations were part of the SCP

deal and SCP provided financing for the Bud Antle deal.

Petitioner contends that the Bud Antle Purchase Agreement also is

a reliable comparable for similar reasons.   Petitioner further

contends that Bud Antle is not related to petitioner and that

petitioner had nothing to do with Bud Antle's selling function,

which is comparable to petitioner's selling function.

Additionally, petitioner contends that the lack of a border-

crossing function does not prevent Bud Antle's other domestic

deals from being comparable to the SCP contract, because the

border-crossing costs are a direct charge borne by the grower.

     We agree that Bud Antle's commission rate in the Bud Antle

amendment and the Bud Antle Purchase Agreement is not a reliable

comparable for petitioner's commission rate in the SCP deal.    Bud

Antle was related to Dole.   Therefore, the 34-cent-per-package

commission rate was not bargained for at arm's length.

Furthermore, Bud Antle received additional compensation through a

share of the profits and the $35,000 payment that petitioner did

not receive.

     Petitioner also contends that the Fresh Choice commission

rate constitutes a comparable for petitioner's commission in the

SCP deal.   Respondent contends that the Fresh Choice joint

venture is not comparable because it varied significantly from
                              - 60 -


petitioner's arrangement under the SCP contract.    Respondent

contends that Fresh Choice received more than the 55-cent

commission rate because Fresh Choice received a share of the

produce sale profits, a marketing fee, and interest on working

capital loans which petitioner did not receive.    Respondent

asserts further that Fresh Choice's fixed costs cannot be

compared to petitioner's fixed costs.   Petitioner contends that

in the Fresh Choice joint venture there were three transactions

(equity contribution, equity line of credit, and distributing

services) for which there were three forms of consideration

(profit share, interest, and commission).    According to

petitioner, the 55-cent commission rate Fresh Choice received

related only to its distribution function.

     We agree with respondent that the additional compensation

Fresh Choice received that petitioner did not receive makes Fresh

Choice's commission rate an unreliable comparable for

petitioner's commission rate in the SCP deal.

     Petitioner also points to the 5-percent-of-gross-sales

commission with 15-cent-per-box handling charge Apache charged

the Canelos growers for selling their No. 2 grade tomatoes as a

reasonable comparable to petitioner's 55-cent-per-package

commission rate in the SCP deal.    Petitioner contends that Apache

provided the same major distribution services for the Canelos

growers that petitioner provided.
                               - 61 -


     Respondent contends that Apache's charges cannot serve as a

comparable to petitioner's commission for the SCP deal because

Apache had lower costs, received part of its income from the

actual purchase and resale of produce, received special benefits

from the Canelos group, had the use of millions of dollars of the

Canelos group's funds for several months until the funds were

transferred, and sold to a different market than the one to which

petitioner marketed.   Respondent contends further that Apache is

not a reliable comparable because, although it did not

technically belong to the Canelos group, it had very close ties

to petitioner and the Canelos group, and it operated as a special

preferred entity of the Canelos group.

     In our view, the additional compensation Apache received in

the form of interest earned on the Canelos growers' funds and the

additional benefits Apache received from petitioner in the form

of uncompensated services petitioner performed for Apache render

the Apache commission an unreliable comparable for petitioner's

commission rate in the SCP deal.   The fact that Apache's

commission rate for its other customers varied between 7 and 12

percent, depending on the services rendered, and indications in

the record that Mexican growers typically paid a higher

commission rate for similar distribution services17 further


     17
       In her writings, Dr. Cook has placed the commission rates
                                                    (continued...)
                               - 62 -


demonstrate that the 5-percent commission rate Apache charged the

Canelos growers was not a reliable comparable for the SCP deal,

especially in light of the fact that a 5-percent commission rate

would have resulted in even higher losses than petitioner already

incurred at the 55-cent-per-package rate.

     Petitioner also contends that the Van Dyke commission rate

of 8 percent of sales constitutes a reliable comparable for

petitioner's 55-cent-per-package rate.   Respondent contends that

the Van Dyke commission rate is not a reliable comparable because

the Van Dyke deal was a limited melon deal for which petitioner

provided fewer services, especially border-crossing services,

than it provided for the Canelos growers in the SCP deal.

     We agree that the 8-percent commission rate is not a

reliable comparable.   Petitioner performed no services for Van

Dyke other than marketing activities and loading and unloading

services, for which Van Dyke reimbursed petitioner.   Van Dyke

handled the warehousing and transporting of the melons.     The Van

Dyke contract did not involve border-crossing activities.

Moreover, Van Dyke reimbursed petitioner for the salary of one of




     17
      (...continued)
charged by distributors to Mexican growers at 8 to 12 percent.
The data on which Dr. Cook relied for those numbers came from the
Confederacion de Asociaciones Agricolas del Estado de Sinaloa
(CAADES) the largest Mexican grower association, and from the
Mexican growers themselves.
                                - 63 -


petitioner's employees making the Van Dyke commission, in effect,

9.5 percent of sales.

     We are persuaded that the 10-percent commission rate paid by

the otros growers is the most reliable comparable commission rate

for the marketing services petitioner rendered in the SCP deal.

Petitioner performed substantially the same marketing services

for the otros growers as it performed for the Canelos growers.

The otros growers were not related to any of the principals in

the SCP deal.   Consequently, negotiations between petitioner and

the otros growers were at arm's length.   The otros growers also

are Mexican growers.    Consequently, their circumstances are more

similar to the Canelos growers' than to the U.S. growers'.    In

addition, the commission petitioner received from the otros

growers served as its only form of compensation for the marketing

services petitioner rendered on their behalf.

     We agree with respondent that the fact that petitioner paid

a portion of the commissions to the Canelos growers does not

require an adjustment of the 10-percent commission rate.   The

contractual arrangement petitioner had with the otros growers did

not require that petitioner give them money advances.   The otros

growers, thus, agreed to pay and did pay petitioner the 10-

percent commission rate regardless of whether petitioner advanced

them funds.   Petitioner's actions in forwarding to the Canelos

growers the difference between the 10-percent-of-sales amount and
                                - 64 -


the 55-cent-per-package amount did not affect the fee the otros

growers owed petitioner for services rendered on their behalf.

     In its briefs, petitioner ignored the adjustment Dr. Frisch

made to account for the payments petitioner made to Mr. Espinosa

in 1989 and 1990 for services he rendered on behalf of the

Canelos brothers or an entity controlled by them other than

petitioner relating to the Canelos growers located in the Baja.

In our view, an unrelated party would not have made those

payments to Mr. Espinosa without seeking reimbursement from the

Canelos growers.   We believe, however, it is not appropriate to

make an adjustment in the commission rate for the years in issue

to account for those payments especially in light of the fact

that those payments were not made throughout the years in issue.

Rather, we believe that, had petitioner not been related to the

Canelos growers, it would have sought direct reimbursement from

them for the payments it made on their behalf to Mr. Espinosa,

similar to the reimbursement petitioner sought and obtained from

the Canelos growers and the otros growers when it paid other

expenses relating to their operations.   Accordingly, we believe,

and so hold, that the adjustment for payments to Mr. Espinosa

should come in the form of a direct reimbursement to petitioner

in the amount of the payment.

     Petitioner contends that no adjustment is needed for the

time value of money because it credited all growers' accounts at
                                - 65 -


the time of sale.   Petitioner ignores the fact that it stipulated

that an additional service it performed for the Canelos growers

that it did not perform for the otros growers was to make sales

proceeds available for immediate disbursement as soon as sales

were made.    Dr. Frisch's 1-percent time-value-of-money adjustment

is aimed at that additional service and appears justified.

Petitioner has presented no data to support a lower adjustment

for this factor; therefore, we accept the amount propounded by

Dr. Frisch.

     We do not agree with petitioner that an adjustment to the

10-percent commission rate is needed for volume considerations.

We believe that, bargaining at arm's length, no unrelated party

would be willing to grant a volume discount which would result in

its consistently operating at a loss.    We also are persuaded that

no adjustment is needed to reflect the variance between the type

of produce petitioner sold for the otros growers and the type of

produce petitioner sold for the Canelos growers.   The record does

not provide sufficient evidence to support the use of that

adjustment or, if it were appropriate, to quantify the amount of

the adjustment.   Similarly, the record does not provide

sufficient data to quantify adjustments petitioner claims are

needed to account for alleged additional services it performed

for the otros growers that it did not perform for the Canelos

growers.
                                 - 66 -


     Furthermore, we do not agree with petitioner that a lower

commission rate is justified because petitioner did not provide

funding for the SCP deal.   SCP lent money to petitioner with

which to make those advances.    Petitioner was principally

responsible for repayment of those loans and for payment of the

interest due on them.   We are persuaded that an unrelated party

under similar circumstances would demand a commission rate in the

higher range.

     Accordingly, on the basis of the foregoing, we hold that for

the years in issue income should be reallocated to petitioner in

a manner to effect a commission rate of 11 percent of sales for

the SCP deal produce petitioner sold during those years.      In

addition, for 1989 and 1990, income should be reallocated to

petitioner in the amount of any payments petitioner made to Mr.

Espinosa on behalf of the Canelos growers.

     To reflect the foregoing,

                                          Decisions will be entered

                                     under Rule 155.
                              - 67 -


                            Appendix


The parties settled some of the adjustments determined in the
notices of deficiency dated Sept. 28, 1995, and Feb. 23, 1996, as
follows:

     1. Petitioner must recognize additional "other
miscellaneous income" for year ending June 30, 1989, in the
amount of $38,731.

     2. Petitioner must recognize additional "farm contract
income" for year ending June 30, 1989, in the amount of $15,456.

     3. Petitioner must recognize "income from the sale of
property" for year ending June 30, 1989, in the amount of
$14,290.

     4. Petitioner must recognize "unreported commission income"
for year ending June 30, 1990, in the amount of $42,787.

     5. Petitioner must recognize "pallet income" for years
ending June 30, 1989 and 1990, in the amounts of $17,852 and
$3,538, respectively.

     6. Petitioner is entitled to "foreign commission expense"
deductions for years ending June 30, 1989 and 1990, in the
amounts of $50,000 and $100,000, respectively.

     7. Petitioner has no "unrelated grower income" for years
ending June 30, 1989, 1990, and 1991.

     8. Petitioner must recognize "commission income--unrelated
growers" for years ending June 30, 1989, 1990, and 1991, in the
amounts of $17,340, $27,475, and $184,616, respectively.

     9. Petitioner is entitled to deductions for "Mexican labor
expenses" for years ending June 30, 1989, 1990, 1991, and 1992,
only in the amounts of $36,840, $33,095, $48,243, and $30,245,
respectively.

     10. Petitioner is entitled to deductions for "legal
expenses" for years ending June 30, 1989, 1990, and 1991, only in
the amounts of $15,700, $12,000, and $19,900, respectively.
Petitioner is entitled to a deduction for "legal and accounting
expenses" for year ending June 30, 1992, only in the amount of
$17,177.
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     11. Petitioner is entitled to deductions for "bad debt
expense" for years ending June 30, 1989, 1990, 1991, and 1992,
only in the amounts of $164,000, $49,201, $130,869, and $4,342,
respectively. Although respondent concedes this issue in the
instant case, respondent does not agree that absorption of the
bad debt expenses by petitioner, the produce distributor, for the
grower is a practice common in the produce industry, but
continues to maintain the positions that (1) a produce
distributor's absorption of the bad debt expense for the grower
is not a practice common in the produce industry, and (2) any bad
debt expense absorbed by petitioner can be taken into account
when calculating the section 482 commission adjustments and/or
additions to tax or penalties.

     12. Petitioner must recognize a $525,000 gain for year
ending June 30, 1990, from the sale of the RCLA Division to
Alejandro Canelos. In addition, petitioner does not have to
recognize any gain from the sale of the RCLA Division for year
ending June 30, 1991, and petitioner is not liable for any
penalty under section 6662(a) for year ending June 30, 1991,
relating to the sale of the RCLA Division property. Petitioner
is liable for a penalty under section 6662(a) for a substantial
valuation misstatement as described in section 6662(e) for year
ending June 30, 1990, relating to the $525,000 gain on the sale
of the RCLA Division property.

     13. Petitioner is entitled to a deduction for "depreciation
expense" for the year ending June 30, 1991, only in the amount of
$214,798.

     14. Petitioner is entitled to a "net operating losses"
deduction for year ending June 30, 1989, in the amount of
$651,171. The $651,171 is the entire allowable "net operating
losses" deduction arising from years prior to year ending June
30, 1989. Unless this Court's determination of the unresolved
issue in the instant cases results in a "net operating loss" for
any of the years ending June 30, 1989, 1990, or 1991, petitioner
will not be entitled to carry forward any "net operating losses"
to year ending June 30, 1992.

     15. Petitioner must recognize "additional income" for year
ending June 30, 1992, in the amount of $19,645.

     16. Petitioner is entitled to a deduction for "charitable
contributions" for year ending June 30, 1992, only in the amount
of $4,470.
                              - 69 -


     17. Petitioner must recognize additional "interest income",
computed under section 482, for year ending June 30, 1989, in the
amount of $150,000. The $150,000 is subject to an addition to
tax under section 6651(a)(1). The additions to tax under
sections 6653(a)(1) and 6661(a) do not apply to the $150,000.

     18. Petitioner does not have to recognize any "interest
income", computed under section 482, for years ending June 30,
1990, 1991, and 1992. The penalties under section 6662(a), (d)
do not apply to the "interest income", computed under section
482, for years ending June 30, 1990 and 1991. There are no
additions to tax under section 6651(a)(1) and (2), or penalty
under section 6662(a) relating to the "interest income", computed
under section 482, for year ending June 30, 1992.

     19. Section 59A controls the environmental tax deduction,
and that deduction will be calculated based on the Court's final
determination as to the taxable income for years ending June 30,
1989, 1990, 1991, and 1992.

     20. For the years in issue, petitioner was a member of a
controlled group, as defined in section 1563. The income tax
brackets, environmental tax exemptions, and any other tax
benefits described in section 1561, will be allocated equally
among the members of the controlled group as specified in section
1561 for years ending June 30, 1989, 1990, 1991, and 1992. For
years ending June 30, 1989 and 1990, the controlled group
consisted of petitioner and Apollo Produce Distributing, Inc.
For years ending June 30, 1991 and 1992, the controlled group
consisted of petitioner, Apollo Produce Distributing, Inc., and
RCLA, Inc.
