                      108 T.C. No. 11



                UNITED STATES TAX COURT



               ASAT, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 3173-95.                     Filed March 31, 1997.



     P, a wholly owned domestic subsidiary, purchased
assembly services from its parent, a foreign
corporation. During an IRS audit of P's 1991 Federal
corporate income tax return, the IRS notified P that it
would need to be appointed its parent's limited agent
under sec. 6038A(e)(1), I.R.C. P did not obtain the
authorization of agent before R issued a notice of
deficiency. Consequently, pursuant to sec.
6038A(e)(3), I.R.C., which grants the Commissioner the
authority to determine in her sole discretion the cost
of goods sold and deductions arising out of
transactions between a domestic corporation and a
related foreign corporation, R determined that P's cost
of goods sold should be decreased and eliminated a net
operating loss (NOL) carryforward which originated from
P's 1989 and 1990 tax years. In addition, R disallowed
P's deduction for consulting fees paid to an unrelated
domestic corporation and applied the accuracy-related
penalty.
                               - 2 -


          Held, sec. 6038A, I.R.C., applies to P for the
     year at issue. Held, further, P failed to obtain the
     authorization of agent required by sec. 6038A(e)(1),
     I.R.C. Held, further, R did not abuse her discretion
     when she adjusted P's cost of goods sold and NOL under
     sec. 6038A(e)(3), I.R.C. Held, further, P may not
     deduct the consulting fees as it did not prove that the
     expense was ordinary and necessary. Held, further, P
     is liable for the accuracy-related penalty.


     James E. Merritt, Linda A. Arnsbarger, and Thomas H. Steele,

for petitioner.1

     Mary E. Wynne, Michael F. Steiner, and Grace L. Perez-

Navarro, for respondent.


     VASQUEZ, Judge:   Respondent determined a deficiency in

petitioner's Federal income tax in the amount of $407,592 and an

accuracy-related penalty under section 6662(a)2 of $81,518 for

its taxable year ending April 30, 1991.   Although respondent gave

alternative grounds for each adjustment in the notice of

deficiency, her first ground in regard to petitioner's cost of

goods sold and net operating loss was section 6038A(e)(3), which

grants the Commissioner the authority to determine in her sole

discretion the cost of goods sold and expenses arising out of

transactions between a domestic corporation and a related foreign

     1
        Counsel of record during the trial and briefing of this
case was Martin A. Schainbaum.
     2
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

corporation (the section 6038A issues).    As resolution of the

section 6038A issues could negate the need for a trial of issues

involving section 482 (section 482 was an alternative ground for

the adjustments), we conducted a separate trial of the section

6038A issues.    With this background in mind, the issues for

decision are:

     (1) Whether section 6038A applies to petitioner for its tax

year ending April 30, 1991; and, if so,

     (2) whether there was a failure to authorize petitioner as

its parent's agent under section 6038A(e)(1); and, if so,

     (3) whether respondent's determination under section

6038A(e)(3), reducing petitioner's cost of goods sold by

$1,494,437, was an abuse of discretion;3

     (4) whether respondent's determination under section

6038A(e)(3), eliminating petitioner's NOL carryforward of

$165,147, was an abuse of discretion;

     (5) whether petitioner may deduct consulting fees of

$280,922;4 and

     (6) whether petitioner is liable for the accuracy-related

penalty under section 6662(a) for negligence.



     3
        References to "abuse of discretion", unless otherwise
indicated, are in the context of a sec. 6038A analysis.
     4
        Petitioner's entitlement to the consulting fee deduction
is not a sec. 6038A issue. See infra.
                                 - 4 -

                         FINDINGS OF FACT

     Petitioner, ASAT, Inc., is a corporation organized under the

laws of California.   At the time the petition was filed, its

principal place of business was in Palo Alto, California.

Petitioner's Organizational Structure

     From December 22, 1988, to at least June 30, 1992 (a period

which includes petitioner's fiscal year ended April 30, 1991, the

year in issue), petitioner was a wholly owned subsidiary of ASAT,

Ltd., a Hong Kong corporation.    During its fiscal year ended

April 30, 1991, ASAT, Ltd., was 85 percent owned by a subsidiary

of QPL International Holdings Ltd. (QPL), a Bermuda corporation

with offices in Hong Kong.   Mr. Li Tung Lok (Mr. Li) was chairman

of the board and the largest single shareholder of QPL during

1990 and 1991.   Petitioner became 95 percent owned by Worltek

International Ltd. (Worltek), a domestic corporation organized in

California, when Worltek purchased 95 percent of petitioner's

stock directly from petitioner on July 15, 1992.     On November 9,

1994, QPL acquired 100 percent of the stock of Worltek.    Hence,

petitioner, once again, became an indirect subsidiary of QPL.

Petitioner's Business5

     Petitioner located semiconductor companies (customers) that

wanted their semiconductor dies put into an assembly package.

These customers contracted with petitioner for assembly services


     5
        Unless otherwise indicated, descriptions of petitioner's
business pertain to its fiscal year ending Apr. 30, 1991.
                                - 5 -

to be provided by ASAT, Ltd., petitioner's foreign parent.

Customers provided the product by drop shipment directly to ASAT,

Ltd., in Hong Kong, for assembly.   Petitioner coordinated the

transaction, sometimes handling the freight forwarding.   ASAT,

Ltd., invoiced petitioner, which then invoiced its customer for

the agreed upon purchase price (the contract price).   After the

customer paid petitioner the contract price, petitioner paid the

invoice received from ASAT, Ltd., by remitting 94 percent of the

contract price to ASAT, Ltd., retaining 6 percent for itself.6

During the fiscal year immediately prior to the year in issue,

petitioner paid ASAT, Ltd., 100 percent of the amounts collected

from petitioner's customers.7   Petitioner reported its receipt of

the contract price on its 1991 Federal corporate income tax

return (tax return) as "Gross receipts or sales".   Petitioner

reported its payments to ASAT, Ltd. for assembly services under

"Cost of goods sold".8


     6
        The 6-percent retained portion of the contract price will
sometimes be referred to as the "gross profit spread" for
convenience. Petitioner and respondent referred to the gross
profit spread as a "commission" and to the 6-percent amount as
the "commission rate" at trial and on brief for convenience.
Although the gross profit spread is similar to a commission, we
are dealing with respondent's determination of the proper amount
of petitioner's payments to its parent, not with the proper
amount of a commission paid by the parent to petitioner.
     7
        The reason petitioner remitted the entire contract price
to ASAT, Ltd., in the tax year ending Apr. 30, 1990, is not in
the record.
     8
        The characterization of the payments in question as cost
of goods sold rather than as a deduction does not affect the
                                                   (continued...)
                                - 6 -

     ASAT, Ltd., had no sales people located in the United States

during its fiscal year ended April 30, 1991.   Petitioner made

purchases on behalf of ASAT, Ltd.   There were no written

agreements between petitioner and ASAT, Ltd., regarding the

purchases petitioner made on ASAT, Ltd.'s, behalf.    Petitioner

paid for all advertising in the United States for itself and

ASAT, Ltd.

Internal Revenue Service (IRS) Audit of Petitioner

     Respondent's examination of petitioner's tax year ending

April 30, 1991 (hereinafter the examination), began when a

notification of the examination was sent to petitioner on July

17, 1992.    The examination continued until December 21, 1994, the

date the statutory notice of deficiency was issued.    Nanette

Alexander Hamilton was the International Examiner who examined

petitioner's tax return for the tax year ended April 30, 1991.

During the examination, Ms. Hamilton met with petitioner's tax

counsel, Martin Schainbaum, and with Fe Maliwat, Robert Borawski,

and Conrad Chapple, all representatives of petitioner.    Ms.

Maliwat was petitioner's controller from April 13, 1991, to

December 31, 1992.   In addition to providing documents to Ms.

Hamilton, Ms. Maliwat responded to inquiries and explained

certain aspects of petitioner's business operations.    Mr.

Borawski was petitioner's counsel and corporate secretary during


     8
      (...continued)
outcome of this case.
                               - 7 -

the examination.   Mr. Chapple has been petitioner's chief

financial officer and senior executive vice-president from

January 1, 1993, to the present.   Prior to 1993, Mr. Chapple was

president of Worltek.

     During the examination Ms. Hamilton issued 11 Information

Document Requests (IDR's) to petitioner.   Ms. Hamilton asked for

the agreements and the basis of how the pricing, commissions, and

service rates were established between petitioner and ASAT, Ltd.,

as well as agreements between petitioner, ASAT, Ltd., and

unrelated parties.   Petitioner never provided these documents,

though petitioner provided copies of invoices to show actual

pricing.   By letter dated October 23, 1992, Ms. Hamilton advised

petitioner's tax counsel that she relied on section 6038A as her

authority to request the documents.

     Ms. Hamilton requested a worldwide organization chart; Hong

Kong income tax returns filed by ASAT, Ltd.; an audited financial

statement of ASAT, Ltd., covering the period under examination;

internal financial statements of ASAT, Ltd., broken down by

product line and subsidiary location; and business plans, market

studies, feasibility studies, corporate minutes, etc., conducted

or developed by ASAT, Ltd., in relation to the organization and

expectations for petitioner.   This documentation was requested

again in a section 6038A summons issued on October 5, 1993.

During a meeting on September 24, 1992, Mr. Schainbaum advised

Ms. Hamilton that petitioner would not produce the information
                               - 8 -

requested on the grounds that the "taxpayer is not ASAT, Ltd."

During the meeting on September 24, 1992, Ms. Hamilton advised

Ms. Maliwat of section 6038A, that respondent had the authority

to request documents concerning ASAT, Ltd., and that she needed

the documents to conduct the examination.   The worldwide

organization chart, the Hong Kong income tax returns, audited

financial statements, and certain internal financial statements

of ASAT, Ltd., were provided to respondent on October 17, 1995,

after the statutory notice of deficiency was issued.   No business

plans, market studies, feasibility studies, or corporate minutes

were provided to respondent.   We cannot tell from the record

whether these items existed or were in the possession of

petitioner.

     Ms. Hamilton notified petitioner's representatives,

including Mr. Borawski, during a meeting on June 14, 1993, that

she was considering an upward adjustment in petitioner's gross

profit spread to 14 percent by lowering its cost of goods sold.

Petitioner's Business as Described by Petitioner's
Representatives to Ms. Hamilton

     During the examination, Ms. Hamilton was told by Mr.

Borawski and Ms. Maliwat that petitioner provided advertising for

the assembly services of ASAT, Ltd.    During the initial interview

of the examination, Mr. Borawski advised Ms. Hamilton that

petitioner's business was contract representative services for

ASAT, Ltd.
                                 - 9 -

     During the initial interview, Ms. Hamilton recorded in her

notes that she was told by Mr. Borawski and Ms. Maliwat that

petitioner was at risk of loss if collection of accounts

receivable was not made, that petitioner provided warranties for

the assembly services of ASAT, Ltd., and that petitioner provided

a 30-day warranty on workmanship and labor.

     Ms. Maliwat explained to Ms. Hamilton that petitioner

purchased, on behalf of ASAT, Ltd., some materials and equipment.

However, the purchasing effort did not require substantial time

or effort as there were probably only five purchases a week.

IRS's Application of Section 6038A

     A.      Notice of Noncompliance

     On November 25, 1992, respondent sent a certified letter to

petitioner and petitioner's counsel requesting that petitioner be

authorized as agent of ASAT, Ltd. pursuant to the provisions of

section 6038A(e)(1) and section 1.6038A-5 Income Tax Regs.    When

respondent issued the request for authorization of agent to

petitioner, Worltek owned 95 percent of petitioner's stock.

Petitioner advised respondent by letter dated January 26, 1993,

that "agency status has not been granted to ASAT, Inc. from ASAT,

Ltd."     Petitioner did, however, obtain an authorization of agent

from ASAT, Ltd., on July 26, 1995, after the notice of deficiency

was issued.

     On June 14, 1993, respondent sent petitioner a certified

letter notifying petitioner that respondent was considering
                                - 10 -

application of section 6038A(e)(3) (hereinafter sometimes

referred to as the noncompliance penalty) for failure to provide

an authorization of agent.   On January 3, 1994, respondent sent

petitioner a certified letter notifying petitioner that she had

applied the noncompliance penalty because petitioner had not

provided respondent with its appointment as agent for ASAT, Ltd.,

and that the noncompliance penalty would be reflected in a notice

of deficiency.   Respondent also informed petitioner that she

would be applying the noncompliance penalty for failure to comply

with a summons that she issued to petitioner.

     B.   Information in Commissioner's Possession

     At the initial interview of the examination on August 26,

1992, petitioner's representatives provided Ms. Hamilton with the

following documents:

     a.   Advertising brochures and folders;

     b.   Table of Contents;

     c.   Organization;

     d.   ASAT, Inc. Chart of Accounts;

     e.   Trial Balance 1991;

     f.   ASAT, Inc. General Ledger FY 1991;

     g.   Cash Receipts FY 1991;

     h.   ASAT, Inc. Cash Disbursements FY 1991;

     i.   ASAT, Inc. Sales Journal FY 1991;

     j.   ASAT, Inc. Freight Invoice Journal FY 1991;

     k.   Adjusting entries;
                               - 11 -

     l.    ASAT, Inc. Intercompany Transactions FY 1991;

     m.    Interco 1989 & 1990;

     n.    Form 1120 (1989); and

     o.    Form 1120 (1990).

All of these documents were in respondent's possession at the

time the notice of deficiency was issued.

     Respondent also had the following documents in her

possession when the notice of deficiency was issued:

     a.    Correspondence between petitioner,
           petitioner's counsel, and respondent;

     b.    notes taken by Ms. Hamilton;

     c.    initial interview questions and notes of the
           initial interview;

     d.    the Manufacturers' Agents National Association
           (MANA) materials;

     e.    Duns Market Identifier for petitioner dated August
           25, 1992; and

     f.    a copy of petitioner's tax return for the fiscal
           year ended April 30, 1992.


     C.    Information Not Available or Not in Existence

     Petitioner did not provide to respondent any budget plans,

work plans, business plans, or other documents showing the

expected income and expenses of petitioner for the years ending

April 30, 1989, through April 30, 1992.   Nor did petitioner

provide to respondent any price lists or price guidelines showing

the prices charged by petitioner and/or ASAT, Ltd., to third

parties.
                              - 12 -

     Petitioner did not make available to respondent any

advertising copy, press releases, brochures, videos, or other

documents distributed to third parties concerning the services

offered by either petitioner or ASAT, Ltd., during the years

ending April 30, 1989, through April 30, 1992.

     During the examination, Ms. Hamilton requested information

regarding how petitioner's gross profit spread was set on sales

of ASAT, Ltd.'s, assembly services.     Neither petitioner nor ASAT,

Ltd., provided any documentation to Ms. Hamilton regarding how

petitioner's gross profit spread was set on sales of ASAT,

Ltd.'s, assembly services.   Petitioner did not provide Ms.

Hamilton with any information as to which company, petitioner or

ASAT, Ltd., set the gross profit spread.

     During the examination, petitioner did not provide

respondent with any documentation on petitioner's anticipated

costs, profits, or break-even points from its transactions with

ASAT, Ltd.   We cannot tell whether this information was not

available or was not in existence.     Petitioner did not provide

Ms. Hamilton with an analysis or projection of income or expenses

for petitioner.   Petitioner did not know what commission rate it

would need to charge ASAT, Ltd., in order to be profitable.

     D.   Application of Section 6038A

     The Internal Revenue Manual provides procedures for the use

and application of section 6038A.    Ms. Hamilton followed the
                                - 13 -

Internal Revenue Manual procedures during the examination in this

case.

     During the examination, Ms. Hamilton was also auditing

another taxpayer that provided services similar to those provided

by petitioner, that is, selling the integrated circuit assembly

services of its foreign parent.    The other taxpayer received a

commission rate ranging from 11 to 15 percent.    The other

taxpayer had three separate divisions.    Two of these divisions

were distributors of goods.   The third division was similar to

petitioner in that it found customers for the integrated circuit

assembly services of the foreign parent.    There was separate

accounting for each activity.    The division which found customers

for the services of the foreign parent had no warehousing

expenses and no inventory.

     To assist in her determination as to the appropriate amount

of petitioner's gross profit spread, Ms. Hamilton consulted with

an economist employed by respondent, Ron McGinley.    During the

examination, Ms. Hamilton related to Mr. McGinley what

petitioner's representatives told her about petitioner's business

and what petitioner's functions were with respect to its sales.

Mr. McGinley provided Ms. Hamilton with information from the

examination of another taxpayer presenting an issue concerning

services rendered similar to that in petitioner's case.    Mr.

McGinley advised Ms. Hamilton that, based upon the functions
                                - 14 -

performed and risks borne by petitioner, a gross profit spread of

10 to 15 percent was appropriate.

     During the examination, Mr. McGinley provided copies of the

following documents to Ms. Hamilton:

     a.   The 1992 MANA Research Bulletin Survey of Sales
          Commissions;

     b.   the 1990 MANA Research Bulletin Survey of Sales
          Commissions;

     c.   an article entitled "Compensating Manufacturers'
          Agents: Guidelines for Determining Agency
          Commissions, Fees and Incentive Programs";

     d.   an article entitled "Guidelines for Determining
          Agency Commissions, Fees Incentive Programs"; and

     e.   the 1992 MANA Survey of Manufacturers' Sales
          Agency Annual Revenues and Expenses.

     The MANA Research Bulletins provide data concerning the

sales commissions charged by agents to their principals.    The

MANA Research Bulletin states:

     Typically, an agent and a manufacturer will offer what
     they feel is a fair rate for the work to be done when
     they negotiate their contract. * * * But, in general,
     fair is a figure whereby both parties can make money
     and where both are pleased with the arrangement. * * *

                    *   *   *     *      *   *   *

     The important point to remember is that a commission
     rate should be determined empirically to insure that
     you and your agencies can make money--read profits.

                    *   *   *     *      *   *   *

          Decide specifically what the agent is expected to
     do in order to receive his basic commission
     compensation.
                                   - 15 -

          Determine what services, in addition to those
     needed to determine the basic commission rate, will be
     needed.

          Determine whether the additional services will be
     paid for as increased commissions or as special fees.

                       *   *   *     *      *    *   *

     [T]he one factor that ultimately rules the marketplace
     is whether or not the agent feels he or she can make a
     decent living with a given commission. * * *

                       *   *   *     *      *    *   *

     [W]hile [many] agents receive most of their income as
     sales commissions, many are also paid fees for special
     services. The typical manufacturers' agency today is
     as likely to perform some special marketing tasks for
     its principals as it is to do its main job of selling
     the products.

Ms. Hamilton interpreted the MANA Research Bulletins as "[making]

it clear that if entities perform additional functions they

should be compensated--additionally compensated for those

functions."

     The MANA Research Bulletin reports sales commission rates in

the categories high, low, and average.          In the product category

of Electronic/Technical Products, the MANA Research Bulletins

show commission ranges of 6.97 percent to 12.19 percent in 1990

and 7.32 percent to 12.30 percent in 1992.           The average rates in

those years were 9.58 percent and 9.81 percent, respectively.

Petitioner performed functions and other activities in addition

to selling the services of ASAT, Ltd.           Ms. Hamilton read the MANA

materials prior to determining her adjustment to petitioner's

gross profit spread.
                                - 16 -

     Ms. Hamilton prepared a "what if" scenario showing the

resulting profit attributable to petitioner for gross profit

spreads of 10 percent through 15 percent.    In her report on Form

4665, Report Transmittal, Ms. Hamilton states, "Providing a

commission [gross profit spread] in the upper range insures that

the TP will report profits from its activities.    In no case

should the commission be reduced below 10 percent.    Ten percent

(10%) is the lowest commission which would result in profit (See

What-if Scenario workpaper)."    If the gross profit spread was

below 10 percent there would be no tax liability.    Ms. Hamilton

testified that there would be no need to process the case if no

additional tax liability would result.

     Ms. Hamilton was guided by temporary regulations under

section 482 which indicated that ranges should be used, even

though she believed the regulations did not apply retroactively.

     As a result of the examination and based upon the

information she had, Ms. Hamilton determined that based on the

additional functions petitioner performed, it should receive a

gross profit spread above the average commission rate shown in

the MANA Research Bulletin for sales services alone.     For the

additional services and functions, Ms. Hamilton determined that

petitioner should be compensated an additional 5 percent above

the average rate of approximately 10 percent as shown in the MANA

materials.
                              - 17 -

     Ms. Hamilton was told by Mr. Borawski that, in his opinion,

the industry average for this type of commission [gross profit

spread] was 5 percent.   Ms. Hamilton knew of Mr. Borawski's 20

years of experience in the industry.   Ms. Hamilton considered Mr.

Borawski's opinion, but did not adopt it in forming her

conclusion.

     E.   Deficiency Notice

     The notice of deficiency was mailed to petitioner on

December 21, 1994.   The notice of deficiency states:

     As required by Section 6038A(e)(1) of the Internal
     Revenue Code and Section 1.6038A-5 of the Income Tax
     Regulations, the foreign related party, ASAT, Ltd.,
     with which you have engaged in transactions, has failed
     to provide the Internal Revenue Service an
     authorization of agent within 30 days of the request by
     letter from the Internal Revenue Service dated November
     25, 1992. See Section 1.6038A-5(b) of the Income Tax
     Regulations. * * *

     Therefore, the noncompliance penalty adjustment under
     Section 6038A(e)(3) has been imposed; accordingly, your
     cost of goods sold [consulting fees expense, net
     operating loss deduction] has been determined based on
     information available to the Internal Revenue Service.
     * * *

Consulting Fees

     In 1990, Mr. Li contacted a friend, Mr. Chapple, president

and 50-percent shareholder of Worltek, and thereafter hired

Worltek to perform an evaluation or review of petitioner.   During

1990 and 1991, two employees of Worltek, Mr. Combs and Mr. Smith,

performed services that were billed to petitioner.   Mr. Combs
                                  - 18 -

worked half-time for Worltek and half-time for petitioner.9

There were no written contracts relating to the hiring or

retention of Worltek employees by petitioner during 1990 and

1991.       Worltek sent petitioner the following invoices:10

Date           Description                           Amount

11/9/90        Consultant fees for W.D. Smith
               for the calendar month of November         $31,000

2/15/91        Consulting fees for W.D. Smith and
               Edward Combs for the month of February
               1991                                           51,000

3/12/91        Consultant fees for W.D. Smith and
               Edward Combs for the calendar month
               of March                                       31,000

4/10/91        Consultant fees for W.D. Smith and
               Edward Combs for the calendar month
               of April                                       55,300

5/10/91        To bill for consulting fees for the
               month of April 1991

                    William D. Smith    24,916
                    Edward G. Combs     38,716                69,63211

These invoices were marked either "Payable upon receipt" or

"Payable on sight".       Handwritten notations on the invoices

indicate that petitioner paid them promptly.


       9
        The record does not show what percentage of time Mr.
Smith worked for petitioner.
       10
        These invoices were provided to respondent in response
to an IDR; the record does not show if these were the only
invoices sent by Worltek to petitioner.
       11
             Worltek's total was incorrect.
                              - 19 -

                              OPINION

     The interpretation and application of section 6038A involve

issues of first impression; there are but two published cases12

that discuss section 6038A.

     In her notice of deficiency, respondent cited the section

6038A(e)(3) noncompliance penalty as statutory support for her

determination.   Section 6038A(e)(3) is available to respondent if

a taxpayer fails to maintain specified records and to honor a

summons as required by section 6038A(e)(2) or if a taxpayer fails

to obtain authorization to be a related foreign corporation's

agent as required by section 6038A(e)(1).   As respondent's notice

of deficiency relies on section 6038A(e)(1), we focus on that

section and its relationship to section 6038A(e)(3).13

     A.   Whether Section 6038A Applies to Petitioner

     Section 6038A provides in pertinent part:



     12
        Asat, Inc. v. United States, 76 AFTR 2d 95-7821, 95-2
USTC par. 50,498 (N.D. Cal. 1995); Nissei Sangyo Am., Ltd. v.
United States, 76 AFTR 2d 95-5736, 95-2 USTC par. 50,327 (N.D.
Ill. 1995).
     13
        The notice of deficiency is predicated on the failure by
petitioner to obtain ASAT, Ltd.'s authorization of agent.
Petitioner's failure, however, to comply with the summons issued
by respondent as required by sec. 6038A(e)(2), and to seek timely
judicial review of the notice of noncompliance as required by
sec. 6038A(e)(4), appears to provide respondent with an
additional ground for applying the noncompliance penalty
adjustment of sec. 6038A(e)(3). See Asat, Inc. v. United States,
supra.
                                 - 20 -

     SEC. 6038A.   INFORMATION WITH RESPECT TO CERTAIN
                   FOREIGN-OWNED CORPORATIONS.

          (a) Requirement.--If, at any time during a taxable
     year, a corporation (hereinafter in this section
     referred to as the "reporting corporation")--

               (1) is a domestic corporation, and

               (2) is 25-percent foreign-owned,

     such corporation shall furnish, at such time and in
     such manner as the Secretary shall by regulations
     prescribe, the information described in subsection (b)
     and such corporation shall maintain * * * such records
     as may be appropriate to determine the correct
     treatment of transactions with related parties as the
     Secretary shall by regulations prescribe * * *.

                     *   *   *     *      *   *   *

          (c) Definitions.--For purposes of this section--

               (1) 25-percent foreign-owned.--A
          corporation is 25-percent foreign-owned if at
          least 25 percent of--

                    (A) the total voting power of all
               classes of stock of such corporation entitled
               to vote, or

                    (B) the total value of all classes of
               stock of such corporation,

     is owned at any time during the taxable year by 1
     foreign person (hereinafter in this section referred to
     as a "25-percent foreign shareholder").

Hence, recordkeeping, reporting, and authorization of agent

requirements under section 6038A apply to "reporting

corporations" who have "transactions" with "related parties".

     1.   Reporting Corporation

     Section 6038A(c)(1) defines a reporting corporation as a

domestic corporation that is 25-percent foreign-owned, meaning
                                - 21 -

ownership by one foreign person of either 25 percent of the

voting stock or 25 percent of the value of all classes of the

domestic corporation's stock.    A "foreign person" is any person

who is not a "United States person" under section 7701(a)(30),

including a corporation.    Sec. 6038A(c)(3); sec. 1.6038A-1(f)(3),

Income Tax Regs.   Petitioner stipulated that it always has been a

corporation and from December 22, 1988, to June 30, 1992, that it

was wholly owned by a foreign corporation, ASAT, Ltd.

Consequently, petitioner is a "reporting corporation" for its

year ending April 30, 1991, the taxable year covered by the

notice of deficiency.

     2.   Related Party

     Section 6038A(c)(2)(A) defines a "related party" to include

any 25-percent foreign shareholder of the reporting corporation.

ASAT, Ltd., owned 100 percent of petitioner at all times during

the year in issue.   Thus, ASAT, Ltd., is a "related party" to

petitioner for its taxable year ending April 30, 1991.

     3.   Transaction

     Section 1.6038A-2(a)(2), Income Tax Regs., provides a

definition of "transaction" in the context of triggering Form

5472 filing requirements:   "A reportable transaction is any

transaction of the types listed in paragraphs (b)(3) and (4) of

this section."

     Section 1.6038A-2(b)(3), Income Tax Regs., provides in part:
                                 - 22 -

          (3) Foreign related party transactions for which
     only monetary consideration is paid or received by the
     reporting corporation. If the related party is a
     foreign person, the reporting corporation must set
     forth on Form 5472 the dollar amounts of all reportable
     transactions for which monetary consideration * * * was
     the sole consideration paid or received during the
     taxable year of the reporting corporation. * * * The
     types of transactions described in this paragraph are:

                    *    *   *     *      *   *   *

               (v) Consideration paid and received for
          technical, managerial, engineering,
          construction, scientific, or other services;

                    *    *   *     *      *   *   *

               (x) Other amounts paid or received not
          specifically identified in this paragraph
          (b)(3) to the extent that such amounts are
          taken into account for the determination and
          computation of the taxable income of the
          reporting corporation.

The above provisions defining a transaction are very broad.

Indeed, petitioner does not dispute, and we hold, that it engaged

in transactions with a related party for its taxable year ending

April 30, 1991, when it contracted with and paid for assembly

services by ASAT, Ltd.   Petitioner nevertheless maintains that

section 6038A is inapplicable for the reasons set forth below.

Before those reasons are examined, however, a review of the

statute's background is in order to provide context to an

analysis of the statute and the parties' arguments.

     4.   Background of Section 6038A

     Section 6038A, as originally enacted in 1982, imposed

reporting requirements on foreign controlled U.S. corporations
                                - 23 -

and branches of foreign corporations.    The Omnibus Budget

Reconciliation Act of 1989, Pub. L. 101-239, sec. 7403, 103 Stat.

2358, added record maintenance requirements that were broadened

by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-

508, sec. 11315(a), 104 Stat. 1388, to affect all open years.

The IRS issued final implementing regulations on June 19, 1991.

Sec. 1.6038A-1, Income Tax Regs., 56 Fed. Reg. 28056 (June 19,

1991).   Section 6038A was drafted to aid the IRS in enforcement

of section 482; its sponsors in the House of Representatives

described it as an effort to "Improve [the] enforceability of

section 482".   H. Rept. 101-247, at 1295 (1989).   The IRS had

experienced difficulties obtaining information from foreign

parents of U.S. corporations.    See United States v. Toyota Motor

Corp., 561 F. Supp. 354 (C.D. Cal. 1983).    The noncompliance

penalty of section 6038A(e)(3) is among the principal enforcement

mechanisms of the statute.

     Section 6038A(e)(3) provides:

          (3) APPLICABLE RULES IN CASES OF NONCOMPLIANCE.--
     If the rules of this paragraph apply to any
     transaction--

                (A) the amount of the deduction allowed under
           subtitle A for any amount paid or incurred by the
           reporting corporation to the related party in
           connection with such transaction, and

                (B) the cost to the reporting corporation of
           any property acquired in such transaction from the
           related party (or transferred by such corporation
           in such transaction to the related party),
                                - 24 -

     shall be the amount determined by the Secretary in the
     Secretary's sole discretion from the Secretary's own
     knowledge or from such information as the Secretary may
     obtain through testimony or otherwise.

     5.     Contentions of the Parties

     Petitioner contends that section 6038A does not apply

because it was not 25 percent owned by a foreign corporation when

respondent requested the authorization of agent on November 25,

1992.     Petitioner further contends that Worltek, a domestic

corporation, became a "successor in interest" to ASAT, Ltd., when

Worltek, on July 15, 1992, purchased newly issued stock from

petitioner and became its 95-percent shareholder.     Under section

1.6038A-5(e), Income Tax Regs., a "successor in interest to a

related party must execute the authorization of agent as

described in paragraph (b) of this section."     Petitioner finally

contends that "Section 6038A is not operative because it was a

legal impossibility for Petitioner to obtain the authorization of

agent."     Petitioner argues that since it "exercised considerable

effort to obtain the authorization of agent from ASAT, Ltd., with

no success" and since it did not have the power to compel ASAT,

Ltd., to grant the authorization of agent, then it should not be

penalized under section 6038A(e)(3).

     Respondent argues that section 6038A is applicable to

petitioner, as it is undisputed that petitioner was a reporting

corporation during the year ending April 30, 1991.     According to

respondent, "the status of a corporation as a 'reporting
                              - 25 -

corporation' for a particular year is unaffected by subsequent

events."   Respondent correctly points out that "Neither section

6038A, the regulations thereunder, nor the legislative history

contains any provision permitting a reporting corporation to

avoid the requirements and penalties of that section for a

particular year because of a subsequent change in stock

ownership."   It is equally true, however, that section 6038A, the

regulations thereunder, and the legislative history make no

mention of the issue whatsoever.    The issue is not whether

petitioner was a reporting corporation for the year in issue--it

was--but whether section 6038A(e)(3) applies for the year in

issue, an issue of first impression.

     6.    Discussion

     We begin our analysis with the well-established rule that

statutory construction begins with the language of the relevant

statute.   Consumer Prod. Safety Commn. v. GTE Sylvania, Inc., 447

U.S. 102, 108 (1980).   Statutes are to be read so as to give

effect to their plain and ordinary meaning unless to do so would

produce absurd or futile results.    United States v. American

Trucking Associations, Inc., 310 U.S. 534, 543-544 (1940); see

Tamarisk Country Club v. Commissioner, 84 T.C. 756, 761 (1985).

Moreover, where a statute is clear on its face, we require

unequivocal evidence of legislative purpose before construing the

statute so as to override the plain meaning of the words used

therein.   Halpern v. Commissioner, 96 T.C. 895, 899 (1991);
                               - 26 -

Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984).    We may

use legislative history to clarify an ambiguous statute.    City of

New York v. Commissioner, 103 T.C. 481, 489 (1994), affd. 70 F.3d

142 (D.C. Cir. 1995).   Even where the statutory language appears

clear, we may seek out any reliable evidence as to legislative

purpose. Id.

      The statute applies to a reporting corporation "If, at any

time during a taxable year," it has "transactions" with "related

parties".   Sec. 6038A(a).   We have already established that

petitioner was a "reporting corporation" that had "transactions"

with a "related party" during the year in issue.    The phrase "If,

at any time during a taxable year" relates to the taxable year

that the reporting corporation has a transaction with a related

party.   Likewise, section 6038A(e)(1) provides in part:

     The rules of paragraph (3) [the noncompliance penalty]
     shall apply to any transaction between the reporting
     corporation and any related party who is a foreign
     person unless such related party agrees (in such manner
     and at such time as the Secretary shall prescribe) to
     authorize the reporting corporation to act as such
     related party's limited agent * * * [Emphasis added.]

Again, the relevant time period is when the transaction took

place.   This interpretation is consistent with the intent of

Congress, as shown by legislative history.    Congress intended for

the IRS to have access to the information necessary to determine

if related party transactions complied with section 482.    The

relevant time period for establishing a taxpayer's status as a

reporting corporation is when the transaction(s) took place; the
                              - 27 -

statute speaks in those terms.   As stated by the Supreme Court in

Commissioner v. Engle, 464 U.S. 206, 217 (1984):

     Our duty then is "to find that interpretation which can
     most fairly be said to be imbedded in the statute, in
     the sense of being most harmonious with its scheme and
     with the general purposes that Congress manifested."
     NLRB v. Lion Oil Co., 352 U.S. 282, 297 (1957)
     (Frankfurter, J., concurring in part and dissenting in
     part). * * *

     Petitioner would have us read into section 6038A(e) the

additional requirement that petitioner be a reporting corporation

at the time the request for authorization of agent is made upon

it by the IRS.   If the statute could be rendered inapplicable by

subsequent ownership changes in a reporting corporation, then it

might lose a substantial part of its efficacy for its stated

purpose.   A subsequent change of ownership in the reporting

corporation, after the taxable year containing the transactions

in question, does not insulate petitioner from the application of

section 6038A(e).

     Petitioner further contends that "Section 6038A is not

operative because it was a legal impossibility for Petitioner to

obtain the authorization of agent."    More accurately stated,

petitioner contends that it was not able to compel its onetime

parent to provide the authorization of agent.    A subsidiary is

generally not in the position to compel its parent to perform any

act; such is the nature of a parent/subsidiary relationship.     The

legislative history to section 6038A discusses the situation

where a related party, which is not known to be such by the
                               - 28 -

reporting corporation at the time the two conduct a transaction,

refuses to authorize the reporting corporation to act as its

agent.   In that situation, the reporting corporation "would

generally be subject to the disallowance rule [noncompliance

penalty] with respect to transactions" with the related party

taking place prior to the time the reporting corporation became

aware that section 6038A would apply.   See H. Rept. 101-247, at

1299 (1989).   Although this result could be called "harsh", the

House report anticipated that no exception would be made unless,

among other conditions, the reporting corporation did not know or

have reason to know that it was conducting transactions with a

related party.   Id.   There is no evidence, and petitioner does

not argue, that it did not know that it was engaged in

transactions with its sole shareholder during petitioner's 1991

tax year.   We reject petitioner's argument that section 6038A

should not apply because petitioner allegedly was unable to

compel its onetime sole shareholder to authorize petitioner as

its agent for purposes of section 6038A.

     We deal next with petitioner's "successor in interest"

argument.   The term "successor in interest" is not defined in

section 6038A or its regulations.   Petitioner argues that

Worltek, a domestic corporation, is a successor in interest to
                               - 29 -

ASAT, Ltd., since Worltek replaced ASAT, Ltd., as majority

shareholder in petitioner.14

     ASAT, Ltd., did not sell its stock in petitioner to Worltek;

rather, after the year in issue petitioner issued stock to

Worltek, which diluted the interest of ASAT, Ltd., in petitioner

from 100 percent to 5 percent.   Respondent correctly points out

that one of the purposes of section 6038A is to allow the IRS to

obtain the records of a foreign related party's transactions with

a domestic corporation through the issuance of a summons.    See S.

Comm. Prt. 101-57, at 112 (1989).   Therefore, "successor in

interest" must be interpreted in that light.   For section 6038A

to accomplish its purpose, the IRS must be able to compel

production of records from the party that has possession of, or

controls the records of, the related party's transactions.     In

this case, the records sought are ASAT, Ltd.'s, a foreign related

party, not Worltek's.   Worltek succeeded to nothing of ASAT,

Ltd.'s.   We conclude that Worltek is not a successor in interest



     14
        Sec. 1.6038A-5(e), Income Tax Regs., provides that "A
successor in interest" to a related party must authorize the
reporting corporation to act as agent. Petitioner argues that
since Worltek is a domestic corporation, it cannot be required to
comply with sec. 1.6038A-5(b), Income Tax Regs., which provides
that "Upon request by the Service, a foreign related party shall
authorize as its agent (solely for purposes of sections 7602,
7603, and 7604) the reporting corporation with which it engages
in transactions." (Emphasis added.) The latter provision
however, does not define "successor in interest". We shall,
nevertheless, address the issue of whether Worltek is a successor
in interest to ASAT, Ltd., and thus would be the proper party to
execute the authorization of agent.
                               - 30 -

to ASAT, Ltd., as that term is used in section 1.6038A-5(e),

Income Tax Regs.   In sum, we hold that section 6038A does apply

to petitioner.

B.   Failure To Designate Agent Issue

     The section 6038A(e)(3) noncompliance penalty is operative

in this case if petitioner did not comply with section

6038A(e)(1), which provides:

     (e) Enforcement of Requests for Certain Records.--

          (1) Agreement to treat corporation as agent.--The
     rules of paragraph (3) shall apply to any transaction
     between the reporting corporation and any related party
     who is a foreign person unless such related party
     agrees (in such manner and at such time as the
     Secretary shall prescribe) to authorize the reporting
     corporation to act as such related party's limited
     agent solely for purposes of applying sections 7602,
     7603, and 7604 with respect to any request by the
     Secretary to examine records or produce testimony
     related to any such transaction or with respect to any
     summons by the Secretary for such records or testimony.
     The appearance of persons or production of records by
     reason of the reporting corporation being such an agent
     shall not subject such persons or records to legal
     process for any purpose other than determining the
     correct treatment under this title of any transaction
     between the reporting corporation and such related
     party.

Petitioner stipulated that it did not obtain the authorization of

ASAT, Ltd., to be its agent until after the notice of deficiency

was issued.   Section 1.6038A-5(b), Income Tax Regs., requires

that the authorization be provided to the IRS within 30 days

after the IRS requests it; petitioner failed to meet the

deadline.
                              - 31 -

C.   Abuse of Discretion Issue

     1.   Standard of Proof

     The standard of review of respondent's determination under

section 6038A(e)(3) is liberal.   Whereas the word "discretion"

does not appear in section 482, when the noncompliance penalty of

section 6038A(e)(3) applies, "the amount of the deduction * * *

and the cost * * * of any property * * * shall be the amount

determined by the Secretary in the Secretary's sole discretion

from the Secretary's own knowledge or from such information as

the Secretary may obtain through testimony or otherwise."

(Emphasis added.)   The conference committee report offers

guidance to a court reviewing respondent's determination under

section 6038A(e)(3):

          The conferees intend that a taxpayer seeking
     judicial review of the exercise of the Secretary's sole
     discretion under the noncompliance rules shall bear the
     burden of proof by clear and convincing evidence that
     the Secretary abused that discretion. The conferees do
     not intend to foreclose a court from overturning a
     determination by the Secretary that was proven (by
     clear and convincing evidence) either to have been made
     with improper motive, or to have been clearly erroneous
     by reference to all reasonably credible interpretations
     or assumptions of facts. On the other hand, the
     conferees do not expect a court to overturn a
     determination unless it could do so even after
     accepting as true all allegations and inferences that
     may support the Secretary's position. [H. Conf. Rept.
     101-386, at 594 (1989).]

     The conference committee report also states:

          Under the conference agreement, in cases of
     noncompliance, the amount of any deduction for any
     amount paid or incurred to the related party by the
     reporting corporation, or the cost of property
                              - 32 -

     transferred between such persons, shall be determined
     by the Secretary in the Secretary's sole discretion,
     based on the Secretary's own knowledge or from such
     information as the Secretary may choose to obtain.* * *

          The conferees wish to clarify that the exercise of
     the Secretary's sole discretion to establish allowable
     amounts of deductions and the cost of goods sold in the
     event of noncompliance shall be subject only to limited
     judicial review. * * * In addition, the conferees do
     not expect a court to overturn a determination on
     grounds that the Secretary might have sought to obtain
     additional information but failed to do so. [Id. at
     593-594.]

     The standard of proof is not identical to that in a section

482 case--proving that the Commissioner's allocations are

arbitrary, capricious, or unreasonable.   Rather, the standard of

proof under section 6038A(e)(3) requires petitioner to show by

clear and convincing evidence and without reference to

information not in respondent's possession or knowledge when the

determination was made, that respondent's determination was made

with an improper motive or is clearly erroneous in light of all

reasonably credible interpretations or assumptions of facts.

     Petitioner has not argued improper motive on the Secretary's

part.   The parties do not disagree on what information was in

respondent's possession when she issued the notice of deficiency

and determined that petitioner's cost of goods sold and net

operating loss should be adjusted downward.   Based on that

information, and that information alone, we must decide if

respondent abused her discretion, applying the standard set forth

above, in determining the deficiency under section 6038A.
                             - 33 -

     2.   Petitioner's Expert Report

     Petitioner submitted an expert report15 (the report) by Dr.

Clark Chandler,16 which opined that it was an abuse of discretion

for respondent to have determined that petitioner should have

received a 15-percent commission [gross profit spread].17

Respondent objected to the admission of the report.   We allowed

the report into evidence, subject to respondent's objection.

However, we advised the parties that they could address the issue

of the report's admissibility on brief.

     We found the report to be of no help to petitioner's case.

Specifically, the report utilized information not in respondent's

possession and did not accept as true credible allegations and

inferences that may support the Secretary's position.   Moreover,

the report equivocated while purporting to form a conclusion ("It

is impossible for me to verify the reasonableness of the IE's

[International Examiner] conclusions.").   The role of an expert

is to assist the trier of fact to understand the evidence or to



     15
        Dr. Clark Chandler prepared a report entitled "ASAT,
Inc., an Economic Evaluation of the International Examiner's
Methodology and Resulting Adjustment."
     16
        Dr. Chandler is an economist with Economic Consulting
Services. The parties stipulated that Dr. Chandler is an expert
in the area of intercompany pricing under sec. 482. Dr. Chandler
received his Ph.D. degrees from the University of Michigan in
1977 and 1978. He has previously testified in numerous cases
before this Court as an expert witness in intercompany pricing.
     17
        Dr. Chandler also referred to the gross profit spread as
a "commission".
                                - 34 -

determine a fact in issue.    Fed. R. Evid. 702.   Under section

6038A(e)(3), we are reviewing whether respondent abused her

discretion in reducing petitioner's cost of goods sold.      The

report itself cannot be considered as evidence of the proper

gross profit spread since it was not in respondent's possession

at the time the determination under section 6038A(e)(3) was made.

The only function the report can serve is to help us evaluate the

information that was in respondent's possession at the time the

determination was made.    The report failed to perform that

function.   The report is not appropriate expert testimony because

it purports to apply a legal standard.    See Laureys v.

Commissioner, 92 T.C. 101, 127-129 (1989).     As explained above,

the test is not identical to a section 482 test, which is Dr.

Chandler's area of expertise.    We are not holding that an expert

report is never appropriate in a section 6038A case, only that to

be considered the report must be helpful in light of the standard

of review called for by the statute.     Dr. Chandler's report did

not provide assistance in that respect.

     3.     Respondent's Section 6038A(e)(3) Determination

     Petitioner had no documentation to show how its gross profit

spread was set.    Respondent, based her determination of a 15-

percent gross profit spread on three main factors:

            a.    Experience With a Similar Taxpayer.

     Ms. Hamilton was examining a taxpayer with a separate

division that conducted a business similar to petitioner's.        That
                                   - 35 -

taxpayer engaged in selling the services of its foreign parent to

assemble integrated circuits, did not maintain inventory, and had

no warehousing expenses.     The taxpayer (a U.S. subsidiary)

received commissions ranging from 11 to 15 percent from its

foreign parent.

            b.    IRS Economist.

        Ms. Hamilton received advice from an IRS economist, Ron

McGinley.     Ms. Hamilton described to Mr. McGinley petitioner's

business and its relationship to its foreign parent.     He told her

that he had experience in determining an appropriate commission

rate for services and that he was currently examining a company

that provided services similar to those provided by petitioner.

Mr. McGinley also told Ms. Hamilton that petitioner should be

compensated for each additional function performed on behalf of

its foreign parent.     Based on his experience, Mr. McGinley told

Ms. Hamilton that a 10 to 15-percent commission range would be

appropriate.

             c.   MANA Survey.

     Mr. McGinley also gave Ms. Hamilton research bulletin

surveys prepared by MANA (the MANA survey).     The MANA surveys

provided data concerning the sales commissions charged by

manufacturing agents to their principals.     In brief, the MANA

survey indicated that a commission rate should enable the agent

to make a profit and that additional services warrant additional

fees.     In the product category of Electrical/Technical Products,
                              - 36 -

the MANA survey reported that commissions ranged from 12.3

percent to 7.32 percent in 1992 and 12.19 percent to 6.97 percent

in 1990.

     Respondent asked for and did not receive information from

petitioner regarding its contractual relationship with ASAT,

Ltd., specific pricing policies, cost analysis, projections,

budgets, or their negotiations in deciding on the proper gross

profit spread.

     Ms. Hamilton used the above factors to determine a basic

gross profit spread of 10 percent and then added 5 percent (15-

percent total) to compensate petitioner for the services that it

rendered to ASAT, Ltd., in addition to locating customers.

     4.    Petitioner's Argument

     Petitioner argues that we may find respondent's

determination to be clearly erroneous by focusing on either her

results or her methodology.   Petitioner argues that it should be

able to present evidence (expert testimony) "to show the correct

costs and expenses based on the information available [not to be

confused with information in respondent's possession] to the

Respondent."

     Petitioner states that a commission rate [gross profit

spread] of 6 percent "was determined by market conditions and is

economically realistic and reasonable."   To support its claim,

petitioner cites a statement by Mr. Borawski (an officer and

employee of petitioner) that the industry average for commissions
                               - 37 -

is 5 percent.    Petitioner also refers the Court to Dr. Chandler's

report in support of petitioner's commission rate.

     Petitioner argues that the IRS economist was "unauthorized

IRS personnel not assigned to the case" and that respondent

should have made him available for trial.18   Petitioner requests

that the Court draw an adverse inference from respondent's not

calling the economist as a witness.

     Petitioner further argues that the international examiner

erroneously relied on noncomparable MANA surveys.    Petitioner

cites section 482 cases for the proposition that the use of

industry averages is not appropriate unless the data is

representative of the taxpayer.   Petitioner points out that it is

not in the manufacturing business and that the MANA survey deals

with manufacturers' agents.

     Petitioner also argues that Ms. Hamilton "erroneously made

an increase to her commission rate adjustment beyond her base

adjustment."    Petitioner argues that since the MANA survey cannot

be shown to have used comparable companies, it is impossible to

know what services are included in the base commission rate.

     Finally, petitioner argues that Ms. Hamilton's use of the

"what if" scenario shows that she backed into the 15-percent




     18
        Despite knowing the economist's identity before
petitioner prepared its pretrial memorandum and that respondent
did not intend to call the economist as a witness, petitioner did
not attempt to subpoena the economist until the day of the trial.
                                - 38 -

gross profit spread.    Therefore, petitioner argues that the

determination is an abuse of discretion.

     5.     Application of Law to Facts

     Petitioner would like us to perform a section 482 analysis;

such an analysis would not be appropriate.     Petitioner, after

failing to provide respondent with basic information about its

related party transactions, argues that respondent determined an

incorrect gross profit spread.     Petitioner's attack on

respondent's results--that respondent's gross profit spread is

not as accurate as petitioner's--ignores the purpose of the

statute.     Section 6038A was enacted to insure that the IRS either

would have timely access to the information necessary to make a

complete analysis of costs between related parties or the right

to make an adjustment based solely on the information that it did

have.     Whether the taxpayer can later justify a cost is

irrelevant:

     Accordingly, the amounts established by the Secretary
     cannot be overturned by a court on the basis that they
     diverge from actual costs or other amounts incurred, or
     on the basis that they do not clearly reflect income.
     The fact that amounts established by the Secretary can
     be proven to be clearly erroneous, by reference to
     information or materials that were not within the
     Secretary's knowledge or possession, would not alone,
     in the conferees' view, be sufficient cause for a court
     to redetermine allowable amounts of deductions and the
     costs of goods sold. * * * [H. Conf. Rept. 101-386, at
     594 (1989).]

     Petitioner argues that Ms. Hamilton should have accepted Mr.

Borawski's opinion that the 6-percent gross profit spread "was
                              - 39 -

determined by market conditions and is economically realistic and

reasonable" since Mr. Borawski had 20 years of experience in the

industry.   Suffice it to say that the IRS is not required to

accept the assertions of interested parties on faith.    In fact,

the legislative history also addressed this point:

           Similarly, the exercise of the Secretary's sole
     discretion in determining how much weight, if any, to
     give to any individual document or other item of
     information that has been submitted is subject to the
     same scope of review, i.e., proof by clear and
     convincing evidence that the Secretary abused that
     discretion, while accepting as true all allegations and
     inferences that may support the Secretary's position.
     [Id.]

     Petitioner's argument that Ms. Hamilton used an

"unauthorized" IRS economist is without merit.    The case cited by

petitioner does not support its argument.19    Nor will we draw an

adverse inference from respondent's not calling the IRS economist

as a witness.   It is not up to respondent to prove that her

determination is correct; it is petitioner who has the heavy

burden.

     If a party fails to introduce evidence within that party's

possession, we may presume in some circumstances that, if

produced, the evidence would be unfavorable to that party.

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165

(1946), affd. 162 F.2d 513 (10th Cir. 1947).    This is true where

the party which does not produce the evidence has the burden of


     19
        Center on Corporate Responsibility, Inc. v. Shultz, 368
F. Supp. 863 (D.D.C. 1973).
                                  - 40 -

proof or the other party has established a prima facie case.           Id.

Petitioner has the burden of proof and has not made a prima facie

showing of the facts which it wishes to establish by adverse

inference.   Petitioner knew the identity of the IRS economist in

ample time to call him as a witness but failed to do so.         Under

these circumstances we shall not draw an adverse inference

against respondent.

     Petitioner argues that Ms. Hamilton erroneously relied on

MANA surveys, which in petitioner's view did not involve

comparable companies or transactions.          Although petitioner is not

in the manufacturing business, it performs a service similar to a

manufacturer's commissioned agent.         Taking into account the

materials within respondent's possession at the time of making

the section 6038A(e)(3) determination, we are not persuaded that

respondent's reliance on the MANA survey was misplaced.

     Petitioner argues that the "what if" scenario shows that Ms.

Hamilton backed into the 15-percent gross profit spread and that

her suggestion that a 10-percent spread would ensure a profit

shows that the determination was arbitrary.         Ms. Hamilton did

calculate the minimum spread necessary for petitioner to show a

profit.   The MANA Research Bulletin states:

     Typically, an agent and a manufacturer will offer what
     they feel is a fair rate for the work to be done when
     they negotiate their contract. * * * But, in general,
     fair is a figure whereby both parties can make money
     and where both are pleased with the arrangement. * * *

                      *   *   *     *      *    *   *
                                 - 41 -

     The important point to remember is that a commission
     rate should be determined empirically to insure that
     you and your agencies can make money--read profits.

It was not an abuse of the Commissioner's discretion under

section 6038A to assume that a fair gross profit spread is one

that would allow petitioner to make an overall profit.

     Petitioner also argues that Ms. Hamilton erroneously

increased the gross profit spread beyond the base adjustment

(from 10 to 15 percent).   However, petitioner admits that it

performed additional services for ASAT, Ltd.    Given the latitude

mandated by section 6038A, we cannot say that the Commissioner

abused her discretion by increasing the base spread by 5-percent

for the additional services.

     Even without the MANA survey, Ms. Hamilton's and the IRS

economist's experiences with similar taxpayers support a gross

profit spread in the 10 to 15-percent range, establishing that

the IRS's determination was not an abuse of discretion.    We hold

that petitioner has failed to show a section 6038A abuse of

discretion in respondent's determination.

D.   NOL

     No NOL deduction is allowed since it was created using a 6-

percent gross profit spread.20    Petitioner admits that a 15-

percent gross profit spread in earlier years would eliminate its

NOL deduction.


     20
        Petitioner's gross profit spread for the 1990 tax year
appears to be zero.
                                - 42 -

E.   Consulting Fees

     The deductibility of the consulting fees is not a section

6038A issue since it does not involve a transaction with a

foreign related party; the consulting payments were made by

petitioner to Worltek, a domestic corporation that was not

related to petitioner at the time.       The parties presented

evidence on the consulting fee issue and argued it on brief.

Therefore, we shall decide the issue.       See Rule 41(b).

     Deductions are a matter of legislative grace; petitioner has

the burden of showing that it is entitled to any deduction

claimed.    Rule 142(a); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934).   To be entitled to a business expense

deduction for consulting fees under section 162, petitioner must

prove that the expenses were:    (1) Ordinary and necessary, (2)

paid or incurred in carrying on a trade or business, (3) incurred

during the taxable year in which the taxpayer seeks to deduct

them, and (4) paid by the person to whom the services were

rendered.   Sec. 162(a).

     Respondent argues that the consulting expenses were the

expenses of ASAT, Ltd. or QPL, and thus not deductible by

petitioner.   We need not decide the issue on that ground as

petitioner has failed to show that the consulting fee expense was

ordinary and necessary.    Whether an expenditure is ordinary and

necessary is generally a question to fact.       Commissioner v.

Heininger, 320 U.S. 467, 475 (1943).       To be "necessary" within
                               - 43 -

the meaning of section 162, an expense need be "appropriate and

helpful" to the taxpayer's business.    Welch v. Helvering, 290

U.S. 111, 113 (1933).    The requirement that an expense be

"ordinary" connotes that "the transaction which gives rise to it

must be of common or frequent occurrence in the type of business

involved."   Deputy v. DuPont, 308 U.S. 488, 495 (1940) (citing

Welch v. Helvering, supra at 114).

     We question whether the consulting fees were determined on

an arm's-length basis.    Mr. Li and Mr. Chapple were friends.

Worltek, a corporation owned 50 percent by Mr. Chapple,

eventually acquired 95 percent of petitioner.    QPL, a corporation

whose majority shareholder was Mr. Li, later acquired Worltek.

There is no evidence in the record of how the consulting fees

were determined.   The monthly amounts, which were usually billed

on the 10th of each month, were for the half-time services of Mr.

Combs and the services of Mr. Smith.    The monthly fees ranged

from $31,000 (for just Mr. Smith) to $124,932 (69,632 + 55,300).

These relatively large amounts--given the size of petitioner's

business--were promptly paid, even though there was no written

contract between petitioner and Worltek and the invoices

themselves provided almost no detail.    There is no evidence in

the record of the skills Mr. Combs and Mr. Smith may have

possessed to warrant such consulting fees.    We hold that

petitioner has failed to prove that the consulting fees were

ordinary and necessary business expenses.
                              - 44 -

F.   Section 6662(a) Accuracy-Related Penalty

     Section 6662(a) imposes a penalty in an amount equal to 20

percent of the portion of the underpayment of tax attributable to

one or more of the items set forth in section 6662(b), including

negligence or disregard of rules or regulations.    Respondent

asserts that the entire underpayment of petitioner's tax was due

to negligence or intentional disregard of rules or regulations.

Sec. 6662(b)(1).   As under the predecessor section covering the

addition to tax for negligence, section 6653(a), petitioner bears

the burden of proof on the penalty in issue.    Rule 142(a); Neely

v. Commissioner, 85 T.C. 934, 947 (1985).    "Negligence" includes

any failure to make a reasonable attempt to comply with the

provisions of the internal revenue laws.    Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.   Negligence is the failure to

exercise due care or the failure to do what a reasonable and

prudent person would do under the circumstances.    Neely v.

Commissioner, supra.   "Disregard" includes any careless,

reckless, or intentional disregard of rules or regulations.      Sec.

6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

     The accuracy-related penalties of section 6662 do not apply

with respect to any portion of an underpayment if it is shown

that there was a reasonable cause for such portion and that the

taxpayer acted in good faith with respect to such portion.     Sec.

6664(c)(1).   The determination of whether a taxpayer acted with

reasonable cause and in good faith depends upon the pertinent
                              - 45 -

facts and circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.

The most important factor is the extent of the taxpayer's effort

to assess his or her proper tax liability.    Id.

     Reliance on a return preparer, however, may relieve a

taxpayer from the addition to tax for negligence where the

taxpayer's reliance is reasonable.     Freytag v. Commissioner, 89

T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd.

501 U.S. 868 (1991).   A taxpayer, however, is not relieved from

liability for the addition to tax for negligence merely by

shifting the responsibility to a tax professional.    Enoch v.

Commissioner, 57 T.C. 781, 802 (1972).    Reliance on an expert is

not an absolute defense but is a factor to be considered.

Freytag v. Commissioner, supra at 888.    A taxpayer's reliance

must be in good faith and demonstrably reasonable.    Ewing v.

Commissioner, 91 T.C. 396, 423 (1988), affd. without published

opinion 940 F.2d 1534 (9th Cir. 1991); Freytag v. Commissioner,

supra at 888-889.   In such a case, a taxpayer will be entitled to

rely upon an expert's advice, even if the advice should prove to

be erroneous.   Jackson v. Commissioner, 86 T.C. 492, 539 (1986),

affd. on other issues 864 F.2d 1521 (10th Cir. 1989); Brown v.

Commissioner, 47 T.C. 399, 410 (1967), affd. per curiam 398 F.2d

832 (6th Cir. 1968).

     The ultimate responsibility for a correct return lies with

the taxpayer, who must furnish the necessary information to the

agent who prepared the return.   Enoch v. Commissioner, supra at
                                 - 46 -

802.   In other words, reliance upon expert advice will not

exculpate a taxpayer who supplies the return preparer with

incomplete or inaccurate information.     Lester Lumber Co. v.

Commissioner, 14 T.C. 255, 263 (1950).

       In this decision, except for the consulting fee issue, among

the rules or regulations to be considered for applying the

negligence penalty are section 6038A and the accompanying

regulations.

       Respondent argues that petitioner did not keep the records

required by section 6038A and did not provide an authorization of

agent when repeatedly asked to do so by respondent.    Respondent

argues that petitioner ignored the requirements of section 6038A

by not keeping records from which respondent could determine the

correct tax treatment of transactions between petitioner and

ASAT, Ltd., citing section 1.6038A-3(a)(1), Income Tax Regs.

Respondent points out that petitioner's 1990 tax return preparer,

a C.P.A. from Deloitte & Touche, informed petitioner in writing

that it "noted concern" in the level of documentation and in

intercompany pricing.    Respondent further argues that petitioner

has not introduced any evidence that it has reasonable cause for

failure to comply with section 6038A.

       Petitioner argues that:

       The evidence adduced at bar demonstrates that
       Petitioner was not negligent. * * *

            Petitioner charged a 6% commission rate to ASAT,
       Ltd. The average commission rate is 5%. Under all the
                               - 47 -

     circumstances of industry competition and individual
     customer order specifications, there is substantial
     economic justification for the rate used by Petitioner
     and reported on its income tax return. * * *

Petitioner further argues that its C.P.A. used "boiler plate"

language regarding intercompany transaction recordkeeping

requirements.    Finally, petitioner argues that it gave its tax

return preparer the information necessary to prepare its return.

     Unfortunately for petitioner, the "evidenced adduced at bar"

does not demonstrate that the industry average commission rate

was 5 percent.    Petitioner confuses the self-serving, unsupported

testimony of its officer with proof.    Saying something is so does

not make it so.   Petitioner had no records whatsoever to document

how it determined the value of ASAT, Ltd.'s services, a

requirement under section 6038A.    Petitioner has not shown that

it attempted to comply with the recordkeeping requirements of the

statute.    Petitioner cannot escape the penalty by blaming its tax

return preparer; petitioner's tax return preparer warned

petitioner that intercompany transactions require documentation.

That this warning was "boiler plate" does not make it any less

true.   We hold that petitioner has failed to prove that it was

not negligent on the section 6038A issues.

     Petitioner has offered no evidence that it was not negligent

in deducting the consulting fees and does not address the issue

on brief.   Respondent's determination of the applicable penalty
                             - 48 -

must be sustained as petitioner has not met its burden of proof

on this issue.

     To reflect the foregoing,

                                      Decision will be entered

                                 for respondent.
