Petitioners further argue that to treat the Smith note as a payment in the year of sale would be contrary to the intention of Congress. They maintain that Congress certainly did not intend for a taxpayer to have to pay a tax on money he has not received. In response to this argument, we need only point out to petitioners that it is the receipt. of income which triggers a Federal income tax and that it is well established that the term "income" as used in the revenue statutes is not limited to cash income. Indeed, where section 453 for some reason is inapplicable, as for example where more than 30 percent of the sales price is received in the year of sale, the entire gain on the sale is taxable in the year of sale even though the balance of the purchase price is represented by property that is not readily convertible to cash. Based upon the authority of Mercedes Frances Freeman, et al., Trust, supra, Georgia-Florida Land Co., supra, and J. W. Elmore, supra, we hold that the Smith note is not an evidence of indebtedness of the purchaser and therefore constitutes a payment to petitioners in the year of sale, and the agreed-upon value of the note must be taken into consideration in determining the profit to be reported in that year. Decision will be entered for the respondent. WOODWARD GOVERNOR COMPANY, AN ILLINOIS CORPORATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket No. 1317-68. Filed October 19, 1970. The petitioner is in the business of manufacturing aircraft and Lajos Schmidt and Robert H. Aland, for the petitioner. SIMPSON, Judge: The respondent determined a deficiency in the petitioner's income tax for its taxable year ended September 30, 1963, in the amount of $146,333.49. One of the issues in this case has been settled. The remaining question to be decided is whether the respondent was authorized under section 482 of the Internal Revenue Code of 19541 to allocate to the petitioner certain income which the parties treated as earned by its subsidiary, Woodward Governor GmbH. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioner is an Illinois corporation, which had its principal office and place of business in Rockford, Ill., at the time its petition was filed in this case. It filed its Federal income tax return for its taxable year ending September 30, 1963, using the accrual method of accounting, with the district director of internal revenue, Chicago, Ill. The petitioner is engaged in the manufacture of prime mover controls, also known as governors, for various types of power units. These controls are divided into three separate product lines: (1) General aircraft (gas turbine and propellor) controls; (2) industrial engine (diesel and gas) and industrial turbine (steam and gas) controls; and (3) hydraulic turbine controls. The manufacture and proper installation and use of its products in power units, particularly of the more complex type such as aircraft engines, require considerable technical and engineering sophistication and know-how. In addition to its main manufacturing facilities at Rockford, Ill., the petitioner had manufacturing plants in Fort Collins, Colo.; Slough, England; Schiphol, the Netherlands; and Tokyo, Japan. The Schiphol, Slough, and Tokyo plants began operations in 1955, 1958, and 1961, respectively. All three foreign plants had assembly, testing, and service facilities, as well as limited machine shop capabilities. The products manufactured in the Schiphol and Slough plants were sold primarily throughout Europe and were for use on industrial engines and turbines, and the products manufactured in the Tokyo plant were sold principally to diesel engine builders in Japan. The net pretax profit earned by the petitioner for 1963 as a percentage of its total sales was 13.5 percent. The net pretax profit earned by the petitioner's Aircraft Controls Division for 1963 as a percentage of its total sales was 17.6 percent. The NATO Starfighter Program Prior to 1959, the Lockheed Aircraft Corp. (Lockheed) developed fighter-interceptor bomber known as the F104 Starfighter (the Starfighter). The Starfighter was selected by the North Atlantic Treaty Organization (NATO) for use in the development and maintenance 1 All statutory references are to the Internal Revenue Code of 1954. of its military potential. Thereafter, NATO initiated a program under which production of the Starfighter airframe (excluding the powerplant and its parts and accessories) was licensed by Lockheed to various construction firms in West Germany, the Netherlands, Belgium, and Italy. At approximately the same time, Lockheed granted similar licenses in Japan and Canada. The Starfighter was powered by an engine developed by the General Electric Co. (GE) and designated by GE as the J-79 gas turbine engine (the J-79 engine). Production of the J-79 engine was licensed by GE to various firms in West Germany, Belgium, Italy, Japan, and Canada. The J-79 engines manufactured by such firms were incorporated into the Starfighter airframes. Development and Selection of the 1307 In 1952, the petitioner began to develop the Type 1307 main fuel control (the 1307) for use in aircraft gas turbine engines. The 1307 is an extremely sophisticated and complex fuel control. Its function. is to control the flow of fuel to the aircraft gas turbine engine under all conditions of altitude, attitude, temperature, acceleration, deceleration, and steady speed. On January 7, 1955, the 1307 was selected by GE as the alternate main fuel control for use in the J-79 engine. At that time, the primary main fuel control was manufactured by the Bendix Corp. (Bendix). In 1957, the 1307 was selected by GE as the primary main fuel control to be used in its J-79 engine and thus replaced the fuel control manufactured by Bendix as the primary fuel control. Petitioner's General Pricing Policy and Procedure The petitioner's first step in arriving at a list price for a product in production quantities is to determine the total manufacturing cost of the product according to its internal cost-accounting procedures. After the total manufacturing costs of the product is determined, the petitioner's next step is to arrive at a net price for the product by adding a profit margin to its total manufacturing cost. Many factors are considered in determining the profit margin, including the market potential, the risk involved, and special circumstances (e.g., special tooling, special test equipment). The net price is used by the petitioner as the selling price when there is only one customer for the product. When there are several classes of customers, the petitioner determines a list price and the appropriate discounts from list price to be allowed to its customers for the product. These discounts are based upon the petitioner's analysis of industry practices and vary as be tween the petitioner's different product lines. For example, the largest or prime discount allowed by the petitioner in its industrial engine and turbine product line is 35 percent, whereas the prime discount allowed by the petitioner in its aircraft product line is 50 percent. Within each product line, the discounts vary according to customer classification, with the prime discounts allowed to so-called "original equipment manufacturers." The final step in arriving at the list price of the product is to add to the net price an appropriate markup so that sales at the list price less prime discount will yield the net price. For example, in the industrial engine and turbine product line in which the petitioner's prime discount is 35 percent, the list price is determined by dividing the net price by 65, the complement of the prime discount, and multiplying by 100. Similarly, in the aircraft produced line in which the prime discount is 50 percent, the list price is determined by dividing the net price by 50, and multiplying by 100. Sales of 1307's to GE The petitioner's first sales of 1307's to GE were of prototype units. The petitioner began to sell 1307's to GE in production quantities in 1957 after GE had selected the 1307 as the primary main fuel control for the J-79 engine, and these sales continued throughout the taxable year in issue and thereafter on a regular and continuing basis. The petitioner's initial sales of 1307's in production quantities to GE were at net prices, which included the total manufacturing cost thereof plus a profit margin. However, prior to 1961, the petitioner developed a list price for the 1307, and in accordance with its general pricing policy, established discounts for the different classes of customers. According to this policy, the 1307's were sold to domestic original equipment manufacturers, and to the U.S. Government, at list price less a 50-percent discount; to foreign manufacturers and foreign governments, at list price less a 35-percent discount; to certain distributors and repair shops, at list price less a 25-percent discount; and to ultimate consumers, at the full list price. Since the establishment of the list price for the 1307's, all sales of such controls to GE have been at the list price less a 50-percent discount. In accordance with its general overall pricing policy of allowing no quantity discounts, the petitioner's allowance of a 50-percent discount from list price to GE for 1307's was not based on the volume or prospective volume of 1307 sales to GE. All 1307's sold to GE were priced f.o.b. Rockford, Ill. The petitioner's trademark was affixed to all 1307's sold to GE. In connection with its sales of 1307's to GE, the petitioner required GE to indemnify it against all liability arising from the testing or use of 1307's. The total volume of the petitioner's sales to GE in the taxable year in issue was $12,349,000, of which $11,158,000 consisted of sales of 1307's. During such taxable year, 75 percent of the profits of the aircraft product line division was derived from the sale of 1307's to GE; some of the sales of that division during that year were of development products on which there was little or no profit. The petitioner was not controlled, directly or indirectly, by GE; nor was GE controlled, directly or indirectly, by the petitioner. Sales and Service of 1307's by GE Beginning in 1957, GE offered for sale and sold all parts and accessories for the J-79 engine, including 1307's, to those firms licensed to produce the J-79 engine. However, GE's license agreements with its licensees did not require the licensees to purchase the parts and accessories from it. GE performed extensive selling activities through its sales apparatus with regard to parts and accessories for the J-79 engine, including 1307's. GE provided warranties against defects in materials and workmanship for all 1307's sold by it. Aircraft Sales to Other Customers Canada required that a certain percentage of the components of J-79 engines manufactured by Orenda Engines Ltd., GE's Canadian licensee, had to be manufactured in Canada. The petitioner considered itself obligated to support GE's J-79 program in Canada by making it possible for 1307's to be manufactured to the required extent in Canada. For that reason, on December 2, 1959, the petitioner entered into a technical assistance agreement with Aviation Electric Ltd. (AEL), an unrelated Canadian subsidiary of Bendix. Under this agreement, the petitioner agreed (1) to sell to AEL certain 1307 parts or components and (2) to furnish AEL with the manufacturing knowhow necessary to enable AEL to manufacture 1307's and certain spare parts therefor in its plant in Canada for use on Canadian-built J-79 engines for Canadian-built Starfighters. The agreement also provided that the petitioner would receive a royalty for its know-how and that it would sell the parts and components to AEL at list less a 50-percent discount. The petitioner sold other products in its aircraft product line to other original equipment manufacturers at list price less a 50-percent discount or at net prices which were the equivalent of list price less a |