                        T.C. Memo. 1997-136



                      UNITED STATES TAX COURT



             PAN AMERICAN FOODS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4875-94.                      Filed March 17, 1997.



     David O. Stevens, for petitioner.

     Sheri Wilcox, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   Respondent determined deficiencies in

petitioner’s Federal income taxes for 1988, 1989, 1990, and 1991,

as follows:
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             Taxable Year Ending           Deficiency

               June   30,   1988            $576,964
               June   30,   1989             632,046
               June   30,   1990             511,793
               June   30,   1991              81,389

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     After settlement, the issue for decision is whether certain

funds transferred to entities related to petitioner constitute

ordinary and necessary business expenses under section 162(a).


                             FINDINGS OF FACT

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

When the petition was filed, petitioner’s principal place of

business was located in Houston, Texas.

     During the years in issue, petitioner operated as the

exclusive U.S. corporate distributor for Gamesa, S.A. de C.V.

(Gamesa), a Mexican manufacturer of food products, such as

cookies, crackers, bakery goods, and pasta.

     In 1984, a Mexican businessman named Alberto Santos de Hoyos

(Santos de Hoyos) formed petitioner as a Texas corporation and as

a wholly owned subsidiary of Cremin Corp., B.V. (Cremin), a newly

formed Netherlands corporation.      Cremin in turn was a wholly

owned subsidiary of Rubbik Corp., N.V. (Rubbik), a newly formed

Netherlands Antilles corporation.
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     Santos de Hoyos indirectly owned 100 percent of Rubbik

through two wholly owned trusts, and he also indirectly owned 9.5

percent of Gamesa through his partial ownership interest in

Gamesa’s majority shareholder.

     As indicated, petitioner was formed in 1984 to operate as

the direct U.S. distributor of Gamesa’s food products.   By

establishing petitioner as its direct U.S. distributor, Gamesa’s

management hoped to capitalize on a growing and profitable market

for Gamesa’s food products in the United States and to reduce the

unauthorized importation of Gamesa’s food products into the

United States.

     Prior to 1984, importers had been purchasing Gamesa’s food

products in Mexico, illegally importing the products into the

United States, and selling Gamesa’s products to supermarkets and

distributors that served U.S. markets.   Products distributed in

the United States in this manner were often outdated or damaged

by the time they reached U.S. markets, sold at discount prices,

and damaged Gamesa’s reputation.

     The U.S. Customs Service (U.S. Customs) will seize “gray

market” imports (i.e., foreign-manufactured products that are

imported into the United States without authorization of the U.S.

corporation holding U.S. trademarks on the products).

     By agreement dated June 12, 1984, Gamesa assigned its U.S.

trademark for “Gamesa” to petitioner to qualify petitioner for

gray market protection with regard to Gamesa’s products that were
                               - 4 -

illegally imported into the United States.   Effective October 17,

1984, petitioner registered the “Gamesa” trademark with U.S.

Customs.   No payment was due from petitioner to Gamesa with

regard to the “Gamesa” trademark.

     In November of 1984, petitioner applied for and was

eventually granted gray market protection by U.S. Customs with

regard to Gamesa’s products.   In its application for gray market

protection, petitioner represented to U.S. Customs that

petitioner and Gamesa were not under common ownership or control.

     In distributing products to U.S. markets, in order to meet

requirements of the U.S. Food and Drug Administration and

preferences of purchasers in the United States, Gamesa made

certain modifications to the ingredients, design, packaging,

marketing, and advertising of many of its products.   Pursuant to

distribution contracts that were entered into between Gamesa and

petitioner, petitioner agreed to supply Gamesa with information

that would aid Gamesa in such modifications of its products for

U.S. markets.   Petitioner did not, however, agree to pay Gamesa a

fee for such modifications.

     The packaging of Gamesa’s products, including those

purchased and distributed in the United States by petitioner,

carried the “Gamesa” trademark and the letter “g” trademark.    The

“Gamesa” and “g” trademarks were added to the packaging of

Gamesa’s products by Gamesa.   Petitioner used both trademarks in

advertising Gamesa's products in the United States.
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     According to records maintained for the years in issue by

U.S. Customs and by the U.S. Patent and Trademark Office, Gamesa,

not petitioner, was the registered owner of the “g” trademark in

the United States.

     During the years in issue, purportedly pursuant to a

licensing agreement between petitioner and Cremin with respect to

the “g” trademark, petitioner transferred funds to Cremin as

follows:


                                      Funds Transferred
           Taxable Year                   to Cremin

              1988                      $   589,462
              1989                          761,506
              1990                          681,601
              1991                          261,057

                     Total              $2,293,626


     The funds transferred by petitioner to Cremin were

periodically deposited into Cremin’s bank account with Citibank

International (Citibank) in Houston, Texas, by Rodolfo de la

Garza (de la Garza), Cremin’s only employee.    De la Garza also

periodically served on petitioner’s and on Gamesa’s boards of

directors.

     Most funds withdrawn from Cremin’s bank account during the

years in issue were transferred to Rubbik.    Gamesa apparently did

not receive any of the above funds that petitioner transferred to

Cremin.

     During the years in issue, petitioner also transferred funds

to Rubbik as follows:
                                - 6 -


                                        Funds Transferred
           Taxable Year                     to Rubbik

                1988                      $1,135,745
                1989                       1,061,050
                1990                         763,790
                1991                          87,050

                       Total               $3,047,635

     Petitioner transferred the above funds to Rubbik pursuant to

five written “consulting” agreements between petitioner and

Rubbik under which Rubbik agreed to provide consulting services

to petitioner relating to the modifications to be made to

Gamesa's products to make them suitable for sale in the United

States.   These agreements were signed by officers of petitioner

at the direction of de la Garza, and the agreements were not

negotiated at arm’s length.

     The services mentioned in the above consulting agreements

were to be performed primarily by Gamesa employees in Mexico, not

by employees of Rubbik.

     The funds transferred by petitioner to Rubbik were deposited

by de la Garza into Rubbik’s bank account with Citibank in

Houston, Texas.    For the years in issue, de la Garza was Rubbik’s

only employee, and he held sole signature authority over Rubbik’s

bank account.

     Most funds withdrawn from Rubbik’s bank account during the

years in issue were transferred to Koala Corp., Ltd. (Koala

Corp), a trust that was indirectly wholly owned by Santos de
                                - 7 -

Hoyos.    Gamesa apparently never received any of the funds that

were transferred by petitioner to Rubbik under the above

consulting agreements.

     During the years in issue, Gamesa did not charge

distributors who distributed Gamesa’s products in Mexico for

services relating to product development, design, packaging, or

marketing of the products.    Further, Mexican distributors of

Gamesa’s products apparently did not make payments to Gamesa

relating to the “Gamesa” or “g” trademarks.

     Effective October 1, 1990, PepsiCo, Inc. (PepsiCo) acquired

a controlling interest in Gamesa, but petitioner continued as the

sole authorized distributor of Gamesa’s products in the United

States.    Until August of 1991, petitioner continued to distribute

Gamesa’s products in the United States bearing the “g” trademark,

and petitioner continued to use the “g” trademark in the United

States to advertise Gamesa's products.

     After PepsiCo acquired Gamesa, petitioner no longer

transferred funds to Cremin and Rubbik.

     On August 6, 1991, at PepsiCo’s insistence, Gamesa

terminated its distribution agreement with petitioner.    At the

same time, petitioner, Cremin, and Rubbik agreed to transfer back

to Gamesa or otherwise cancel any and all rights they possessed

to the “g” trademark.    PepsiCo required this cancellation of

rights to the “g” trademark because PepsiCo could not determine
                               - 8 -

exactly which company or companies owned rights to the “g”

trademark.

     On its Federal income tax returns for the years in issue,

petitioner claimed business expense deductions for the total

$2,293,626 in funds transferred to Cremin and for the total

$3,047,635 in funds transferred to Rubbik.

     On audit, respondent disallowed petitioner’s claimed

deductions for the funds transferred to Cremin and Rubbik on

grounds that the deductions did not constitute ordinary and

necessary business expenses under section 162(a).


                              OPINION

     A taxpayer may deduct all ordinary and necessary expenses

incurred in carrying on a trade or business.   Sec. 162(a).

Ordinary expenses are described as those expenses that are

normal, common, and accepted within a taxpayer’s trade or

business, and necessary expenses are described as those that are

helpful and appropriate to a taxpayer’s trade or business.      Tulia

Feedlot, Inc. v. United States, 513 F.2d 800, 804 (5th Cir.

1975); Boser v. Commissioner, 77 T.C. 1124, 1132 (1981).

Transactions between a taxpayer and related parties are subject

to special scrutiny.   Tulia Feedlot, Inc. v. United States, supra

at 805.   Generally, a taxpayer has the burden of proof and must

prove the deductibility of claimed deductions.   Rule 142(a).

     Petitioner argues that the funds transferred to Cremin and
                               - 9 -

Rubbik represented part of the total wholesale price charged by

Gamesa to petitioner for Gamesa’s products, that the funds could

have been paid directly to Gamesa as part of the price of the

products, and that the funds were transferred instead to Cremin

and Rubbik to bolster the appearance that Gamesa and petitioner

were not controlled by the same owners so that petitioner would

qualify for gray market protection with regard to Gamesa's

products distributed in the United States.

     With regard specifically to the $2,293,626 in funds

transferred to Cremin, petitioner argues that it received rights

to the “g” trademark through Cremin and Rubbik and that Rubbik

had received its rights to the “g” trademark from Gamesa, that

the funds transferred to Cremin constituted royalties paid

pursuant to the alleged licensing agreement between petitioner

and Cremin, and that the funds transferred to Cremin, therefore,

constituted ordinary and necessary business expenses.

     With regard specifically to the $3,047,635 in funds

transferred to Rubbik, petitioner argues that Rubbik, through de

la Garza, served as a broker of the services performed by Gamesa

to customize its products for U.S. markets and that the funds

transferred to Rubbik, therefore, constituted ordinary and

necessary business expenses.

     Respondent argues that petitioner was not obligated to pay

Cremin royalties because Cremin never owned any rights to the “g”

trademark, that neither Rubbik nor de la Garza acted as a broker
                               - 10 -

of the services performed by Gamesa to customize Gamesa’s

products for U.S. markets, that product manufacturers do not

customarily charge distributors directly for services similar to

those performed by Gamesa, and therefore, that the funds

petitioner transferred to Cremin and Rubbik did not constitute

ordinary and necessary business expenses.

     We agree with respondent.   The ordinary and necessary nature

of the funds transferred by petitioner to Cremin and Rubbik and

petitioner’s arguments in support thereof are not supported by

the evidence.

     Petitioner’s argument assumes that Gamesa somehow received

the benefit of the funds that petitioner transferred to Cremin

and Rubbik.   The facts indicate, however, that Gamesa did not

receive any such benefit.    Nor does the record indicate that the

funds transferred to Cremin and Rubbik facilitated in any way

petitioner’s qualification for gray market protection for

Gamesa's products.

     With regard to the $2,293,626 in funds transferred to

Cremin, the facts do not indicate that Cremin owned any rights to

the “g” trademark when it entered into the alleged licensing

agreement with petitioner.   Petitioner’s expert’s opinion

regarding the ownership of the “g” trademark was generally

unpersuasive, not supported by the evidence, and not credible.

     Also, for the years in issue, Gamesa (not petitioner, not

Cremin, and not Rubbik) was the registered U.S. owner of the “g”
                              - 11 -

trademark.   No other entity recorded or registered any rights to

the “g” trademark.   After terminating its payments to Cremin upon

PepsiCo’s acquisition of an interest in Gamesa, petitioner

continued to distribute Gamesa’s products, and petitioner

continued to use the “g” trademark for advertising purposes.

These facts refute the claimed relationship between the funds

transferred by petitioner to Cremin and petitioner’s use of the

“g” trademark.

     We note that PepsiCo, after acquiring an interest in Gamesa,

could not even determine which companies owned the rights to the

“g” trademark.   PepsiCo simply required that all of the related

companies transfer back to Gamesa or otherwise cancel any and all

rights they may have owned to the “g” trademark.

     Petitioner also has not established that it is customary for

a distributor to make payments similar to those involved in this

case relating to a manufacturer's products.   We note that Mexican

distributors of Gamesa’s products did not make any similar

payments.

     With regard to the $3,047,635 in funds transferred to Rubbik

during the years in issue, if in fact the funds represented

payment for services performed by Gamesa, petitioner has not

adequately explained why the funds were transferred to Rubbik,

and not to Gamesa.   Petitioner’s claim that de la Garza served as

a broker of the services performed by Gamesa is not supported by

the evidence.
                             - 12 -

     The funds transferred by petitioner to Rubbik were deposited

into Rubbik’s bank account and then transferred to Koala Corp.

The evidence does not indicate that Gamesa received any funds

from Rubbik, from petitioner, or from Koala Corp., for services

that it performed to customize its products for U.S. markets.

     The services provided by Gamesa, such as product design and

packaging, are the type of services that manufacturers

customarily perform on their own behalf and for which separate

charges are not made to distributors.    Also, the distribution

agreements between Gamesa and petitioner did not provide that

petitioner would make payments to Gamesa for services relating to

product modifications.

     The evidence does not establish that the funds transferred

by petitioner to Cremin and Rubbik constituted ordinary and

necessary business expenses under section 162(a).

     We have considered the parties’ other arguments and find

them without merit.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.
