In this case a pharmaceutical company in the US, Eli Lilly & Co, transferred valuable pharmaceutical patents and manufacturing know-how to its subsidiary in Puerto Rico.
The IRS argued that the transaction should be disregarded (substance over form) and claimed that all of the income from the transferred intangibles should be allocated to the U.S. parent.
The Judgment from the Tax Court: “Respondent’s argument, that petitioner, having originally developed the patents and know-how, is forever required to report the income from those intangibles, is without merit. Respondent ignores the fact that petitioner, as developer and owner of the intangible property, was free to and did transfer the property to the Puerto Ricanaffiliate in 1966.”
The Court of Appeals altered the judgement from the Tax Court. According to the Court of Appeals, the parent company had received an arm’s length consideration for the transfer of intangibles in the form of stock in the subsidiary. Hence, the Court disallowed the allocation of the intangibles’ income to the U.S. parent.