                        T.C. Memo. 2000-357



                      UNITED STATES TAX COURT



    UNION GANADERA REGIONAL DE CHIHUAHUA, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12521-98.           Filed November 16, 2000.



     Elizabeth A. Copeland and Stanley L. Blend, for

petitioner.

     Elizabeth A. Owen, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:   Respondent made the following determinations,

which petitioner contests:
                                - 2 -

Re:    Federal Income Tax Deficiencies:

                      Year              Deficiency

                      1992              $74,225
                      1993               94,903

Re: Deficiencies For Withholding of Income Tax At Source and
Additions to Tax:

                  Withholding            Additions to Tax
Year              Deficiency        Sec. 6651(a)(1)    Sec. 6656

1992                $53,608               $13,402       $5,361
1993                107,107                26,777       10,711

       All section references are to the Internal Revenue Code (the

Code) in effect for the years in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.

       Following a concession by each party, we must decide whether

petitioner, a U.S. corporation that owned and operated a cattle-

crossing facility on the United States (U.S.) side of the U.S.-

Mexican border, is entitled to deduct amounts paid to its Mexican

parent company in 1992 and 1993 with respect to costs incurred by

the parent company for inspection and bathing of cattle crossing

the border.    If we conclude that the amounts are not deductible,

then we must decide (1) whether petitioner’s payments to its parent

company constitute dividend payments, for which petitioner was

required to withhold 30 percent pursuant to section 1442; (2)

whether petitioner was required to file Federal withholding tax

returns, Forms 1042, Annual Withholding Tax Return for U.S. Source

Income of Foreign Persons, for 1992 and 1993; and (3) whether

petitioner is liable for additions to tax pursuant to sections
                                 - 3 -

6651(a)(1) and 6656 (with regard to the withholding of income tax

at source).

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.   The

stipulations of facts and the attached exhibits are incorporated

herein by this reference.

Background

     Union Ganadera Regional de Chihuahua (Union Mexico) was a

Mexican, nonprofit agricultural cooperative, established in 1936.

It was organized to assist its members (namely, 43 individual

cattle associations, totaling approximately 3,000 Mexican cattle

ranchers) in the crossing of cattle from Mexico into the United

States and vice versa. Union Mexico was the parent company of Union

Ganadera Regional de Chihuahua, Inc. (petitioner), a New Mexico

corporation organized in 1991.    At all relevant times, petitioner

maintained its principal place of business in Santa Teresa, New

Mexico.

     Petitioner assisted Union Mexico in the crossing of cattle

over the U.S.-Mexican border.      It employed eight individuals in

conducting its cattle-crossing activities on the U.S. side of the

border; whereas, Union Mexico employed 45 individuals in conducting

its cattle-crossing activities on the Mexican side of the border.
                               - 4 -

The Cattle Export/Import Business

     Prior to the establishment of petitioner’s facilities, Union

Mexico owned three cattle-crossing facilities in the State of

Chihuahua, Mexico:   Ciudad Juarez, Ojinaga, and Palomas.1   At each

of these facilities, cattle were inspected and bathed to rid the

cattle of parasites (bathing) before crossing into the United

States.

     Before petitioner was incorporated, Union Mexico did not own

any cattle-crossing facilities in the United States.         Rather,

cattle crossed into the United States from Mexico by way of

unrelated, privately owned U.S. stockyards.2

     Union Mexico organized petitioner to own and operate a cattle-

crossing facility (the Santa Teresa facility) on the U.S. side of

the U.S.-Mexican border directly across the border from its San

Jeronimo facility.   The Santa Teresa facility was located in Santa




     1
          At the time of trial, only the Ojinaga and Palomas
facilities operated.
     2
          Kattle Kare, Inc., operated by Butch Stevens, owned a
stockyard in Columbus, New Mexico, directly across the U.S.
border from Union Mexico’s Palomas facility. Prior to the
construction of the San Jeronimo/Santa Teresa facility, the
Palomas/Columbus cattle crossing was the predominant U.S.-Mexican
cattle crossing. During the years in issue, Kattle Kare, Inc.
charged $3.50 per head of cattle for crossing the border and 1
day of boarding (including hay for 1 day).
     In addition, several privately owned corrals existed with
respect to the Ojinaga facility (used to house the livestock on
the U.S. side of the border).
                                - 5 -

Teresa, New Mexico, just outside the city limits of El Paso, Texas.

It began its cattle-crossing operations in 1992.

     The combined cattle-crossing facilities at San Jeronimo and

Santa Teresa were integrated facilities, consisting of 92 acres

that straddle the U.S.-Mexican border. Petitioner owned 39 percent

of the total acreage (at Santa Teresa), and Union Mexico owned 61

percent (at San Jeronimo).      To cross the U.S.-Mexican border,

cattle walked approximately 120 feet from the San Jeronimo facility

(in Mexico) to the Santa Teresa facility (in the United States).

     The Santa Teresa facility, together with the San Jeronimo

facility:   (1) Provided efficiencies of scale for crossing cattle

over the U.S.-Mexican border by providing an integrated cattle-

crossing location; (2) improved the quality of the U.S. facilities

that receive Mexican cattle; (3) reduced theft, stress, and weight

loss of the cattle; and (4) reduced Union Mexico’s losses in

exporting cattle.

     The San Jeronimo facility included a building with bathing

facilities, cattle pens, weighing facilities, and offices. It

housed Union   Mexico’s   cattle-crossing   operations   and   provided

office space for U.S. Department of Agriculture (USDA) inspectors

and their Mexican counterparts. At this location, Union Mexico

coordinated (1) the receipt of cattle from the trucks, (2) the

holding and feeding of cattle, (3) the weighing of cattle, (4) the

inspection of cattle, (5) the bathing of cattle, and (6) the
                                     - 6 -

corralling of cattle acceptable for export to the United States.

The Santa Teresa facility included a building, sorting and weighing

facilities, and cattle pens.

        Petitioner accepted the USDA-approved cattle from the San

Jeronimo facility and sorted and temporarily housed the cattle

until a U.S. purchaser arrived.3           (Usually this occurred within 24

hours       or   less.)   Union   Mexico    provided   all   of   petitioner’s

electricity and water.

     The cattle generally spent 15 to 20 hours at the San Jeronimo

facility and 8 hours at the Santa Teresa facility. Before the

cattle left petitioner’s facility, a customs broker (an independent

contractor unrelated to petitioner or Union Mexico) collected fees

from the Mexican rancher/seller, including a $3 fee for each head

of cattle that crossed through the facility. Thereafter, the


        3
          The operations at the San Jeronimo/Santa Teresa
facilities were as follows: (1) A Mexican rancher delivered his
cattle to one or more of the eight unloading docks at the San
Jeronimo facility, at a scheduled date; (2) the cattle were
counted, weighed, and then housed, fed, and watered; (3) the
cattle rested for 6 to 12 hours; (4) Union Mexico’s employees
thereafter herded the cattle into inspection chutes where USDA
inspectors and their Mexican counterparts inspected the
livestock; rejected cattle remained in Mexico; (5) Union Mexico
provided offices, water, and electricity free of charge to the
USDA and Mexican inspectors; (6) the USDA-approved cattle were
herded out of the inspection chutes into bathing pools, where the
cattle were dipped fully in chemicals and sent to clean holding
pens; (7) after the cattle were dried, they were moved through
the Mexican corrals and herded on foot approximately 120 feet to
petitioner’s Santa Teresa facility; (8) here, the cattle were
herded through chutes, reweighed, and housed in feeding/watering
pens; and finally, (9) the cattle were loaded onto trucks for
shipment to the U.S. buyer.
                                    - 7 -

customs   broker   remitted   the    $3     per   head   of   cattle   fee   to

petitioner.     (This   fee   also   included      the   cost   of   necessary

paperwork and feed for 1 day.)       If the cattle remained overnight,

petitioner charged an additional $6 fee for each bale of hay

consumed.

     Petitioner agreed to pay Union Mexico $1.50 of the $3 per head

of cattle fee as petitioner’s share of the water, electrical,

inspection, and bathing expenses.           This $1.50 per head of cattle

fee was determined by estimating the costs Union Mexico incurred in

connection with crossing the cattle into the Santa Teresa facility

from the San Jeronimo facility and allocating one-half of these

costs to petitioner.    The financial arrangement between petitioner

and Union Mexico was set forth in a January 2, 1993, contract4.

     4
            The contract, in relevant part, states:

     FIRST.--Union Ganadera Regional de Chihuahua, as the
     party in charge of facilitating the export of cattle to
     the United States, is obligated to program deliveries
     of cattle through the San Jeronimo installations so
     that said cattle reach the stockyards of Union Ganadera
     Regional de Chihuahua, Inc. in Santa Teresa.

     SECOND.--Union Ganadera Regional de Chihuahua is also
     obligated to provide Union Ganadera Regional de
     Chihuahua, Inc. various services that are necessary its
     [sic] effective operation and that are described as
     follows: Water, by means of extraction and pumping from
     a well located on the property of Union Ganadera
     Regional de Chihuahua that will be delivered to the
     piping to Union Ganadera Regional de Chihuahua, Inc. at
     the North American border; Electrical Energy, through
     adequate technical connections located in the
     installations of Union Ganadera Regional de Chihuahua
     Inc’s. at the North American border; Sanitary
                                                   (continued...)
                                  - 8 -

Petitioner's   Federal   Income   Tax     Returns   and   the   Notices   of
Deficiency

     On its 1992 Form 1120X, Amended U.S. Corporation Income Tax

Return, petitioner claimed a $204,288 deduction for amounts it

paid to Union Mexico.    Respondent disallowed that portion of the

claimed deduction (totaling $181,137) that related to payment for

inspection and bathing costs but allowed that portion relating to

Union Mexico’s furnishing of water and electricity to petitioner.




     4
      (...continued)
     Inspection and Parasitical Bath, required by the
     governments of both countries for the exportation of
     cattle, for the cattle that are exported to Santa
     Teresa, to be performed by its personnel in its
     installations at San Jeronimo.

     THIRD.--As payment for the referenced services, Union
     Ganadera Regional de Chihuahua, Inc. is obligated to
     pay Union Ganadera Regional de Chihuahua the amount
     established by both parties as annexed to this
     agreement, for each head of cattle that is exported
     through the Sanitary Unit at San Jeronimo to the
     stockyeards [sic] at Santa Teresa.

     The attachment to the contract states as follows:

     In conformity with the THIRD CLAUSE of the contract,
     both parties agree on a charge of US$1.50 (ONE DOLLAR
     AND FIFTY CENTS) per head of cattle that crosses from
     the Sanitary Unit at San Jeronimo to the stockyards at
     Santa Teresa, New Mexico.
                                      - 9 -

Subsequently, respondent reduced the disallowed amount to $178,694

to   reflect     an    additional    allowance    of    $2,443    for   water   and

electricity costs.5

      On its 1993 Form 1120, U.S. Corporation Income Tax Return,

petitioner claimed a $397,519 deduction for amounts it paid to

Union Mexico.         Respondent again disallowed that portion (totaling

$357,024) that related to payment for inspection and bathing costs.

      Respondent disallowed the payment for inspection and bathing

costs on the basis that the costs for these expenses were not

properly allocable to petitioner, but rather were those of Union

Mexico.     As    a    consequence    of   this   determination,        respondent

characterized petitioner’s payments to Union Mexico as constructive

dividends (representing a distribution of petitioner’s earnings and

profits to its foreign parent company).

      Respondent further determined that petitioner should have

withheld income tax at the source, pursuant to section 1442, with

respect to purported dividends ($178,694 for 1992 and $357,024 for

      5
            The following summarizes the processing fees adjustment
for 1992:

Total processing fees claimed:
  Inspection, bathing,
    water, and electricity                             $204,288
Processing fees allowed:
  Water                                                  10,214
  Electric                                               12,937
Processing fees disallowed:
  Inspection, bathing                                   181,137
Additional allowance:
  Water and electric                                      2,443
Disallowance                                            178,694
                                       - 10 -

1993).       Thus, respondent determined withholding deficiencies of

$53,608      for   1992   and   $107,107      for   1993.    Lastly,     respondent

determined that petitioner was liable for sections 6651(a)(1) and

6656 additions to tax.

                           ULTIMATE FINDINGS OF FACT

       The amount petitioner paid Union Mexico with respect to the

costs for inspection and bathing of cattle was an ordinary and

necessary section 162 expense.

                                       OPINION

       Our task is to decide whether petitioner is entitled to deduct

the payments it made to Union Mexico for costs of inspection and

bathing of cattle crossing into the United States (at petitioner’s

Santa Teresa facility) from Mexico.                  Petitioner maintains that

these payments were ordinary and necessary business expenses.

Respondent disagrees, and further argues that the disallowed fees

represented disguised dividends paid by petitioner to its sole

shareholder.        Respondent further maintains that inasmuch as the

inspection and bathing processes occurred at Union Mexico’s San

Jeronimo facility prior to the cattle crossing into the United

States, the fees for these expenses (insofar as petitioner is

concerned) are neither customary nor appropriate.

       The    applicable       Code   provision     is   section   162(a),   which

provides that “There shall be allowed as a deduction all the

ordinary and necessary expenses paid or incurred during the taxable

year   in    carrying     on    any   trade   or    business”.     The    test   for
                                      - 11 -

determining whether an expense is ordinary and necessary is whether

a “hard-headed” businessperson, under the circumstances, would have

incurred the expense.           See, e.g., Cole v. Commissioner, 481 F.2d

872, 876 (2d Cir. 1973), affg. T.C. Memo. 1972-177.             Because of the

relationship between petitioner and Union Mexico,6 the expenses at

issue are subject to close scrutiny.             See Higgins v. Smith, 308

U.S. 473 (1940).

        In the case at bar, the record reflects that petitioner

reimbursed Union Mexico for its share of the inspection and bathing

expenses, and not for any nefarious reason. Petitioner’s and Union

Mexico’s businesses were directly linked.                  The inspection and

bathing       expenses   were    shared    business-related    expenses,     and

petitioner and Union Mexico benefited equally from the inspection

and bathing functions carried out by Union Mexico.               The benefits

derived from the inspection and bathing of cattle ensured the

continued      viability   of    petitioner’s    cattle-crossing       business.

Thus, we are satisfied that the entire amount petitioner paid to

Union       Mexico   constituted    an    ordinary   and   necessary   business

expense.      The inspection and bathing of cattle on the Mexican side

of the border was required before petitioner could import the

cattle into the United States. Petitioner’s revenues were based on

the flow of USDA-approved cattle originating in Mexico to U.S.

buyers.


        6
               The parties agree that sec. 482 is not at issue.
                                       - 12 -

     We reject respondent’s argument that the costs Union Mexico

incurred for inspection and bathing of the cattle are strictly

Union        Mexico   expenses     (which    should      not   be     passed   on   to

petitioner).          The cattle-crossing operation was an integrated

operation.       Petitioner paid Union Mexico the disputed fees for its

share of the expenses incurred to perform necessary activities in

the ordinary course of its business.

     To       conclude,    the    expenses       at   issue    were    critical     and

indispensable to petitioner's business and therefore were ordinary

and necessary business expenses.                 Accordingly, we hold that the

expenses relating to the costs of inspection and bathing of cattle

in Mexico were properly deductible as ordinary and necessary

business expenses and did not constitute constructive dividends.

Because of this holding, the remaining issues go by the wayside.

        In    reaching    our    holding,   we    have   considered     all    of   the

arguments presented and, to the extent not discussed above, find

them to be irrelevant or without merit.

     To reflect the foregoing and the parties’ concessions,



                                                       Decision will be entered

                                                 under Rule 155.
