T.C. Memo. 1996-280

UNITED STATES TAX COURT

APOLLO OVERSEAS INTERNATIONAL, INC., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5031-94. Filed June 17, 1996.

James S. Yan, for petitioner.

Clifton B. Cates III and Nancy C. McCurley, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SCOTT, Judge: Respondent determined deficiencies in

petitioner's Federal income taxes and additions to tax for the

taxable years ended January 31, 1988, 1989, and 1990, as follows:
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 Additions to Tax 

Tax year Sec. Secs. 6653(a)(1)(A)/ Sec. Sec.

 ended Deficiency 6651(a) 6653(a) 6653(a)(1)(B) 6661(a)

1/31/88 $145,156 $36,289 $7,258 1 $36,289

1/31/89 289,298 72,325 14,465 -0- 72,325

1 Plus 50% of the interest that is computed on $145,156 for the 

taxable year ended Jan. 31, 1988, at the time of assessment and/or 

payment of tax.

Tax year Addition to Tax Penalty

 ended Deficiency Sec. 6651(a) Sec. 6662(a)

1/31/90 $490,772 $122,693 $98,154

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, unless otherwise

indicated.

Some of the issues raised by the pleadings have been

disposed of by agreement of the parties (including all issues

pertaining to the taxable year ended January 31, 1988 (fiscal

year 1988)), leaving for decision the amount of customs duties,

freight charges, and related fees paid by petitioner with respect

to its goods purchased for sale during each of the years here in

issue, which, when added to the agreed cost of purchases other

than these charges, results in cost of the goods purchased. The

parties agree as to whether the additions to tax and penalty

apply to petitioner and that the amount of such additions to tax

and penalty will be computed under Rule 155.
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FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly.

Petitioner Apollo Overseas International, Inc., is a

California corporation with its principal place of business in

Santa Fe Springs, California, at the time of the filing of the

petition in this case. Petitioner filed a Federal income tax

return for each of its taxable years ending January 31, 1988,

1989, and 1990 with the Internal Revenue Service Center in

Fresno, California.

Petitioner was engaged in the business of importing clothing

(garments) and cloth badges (badges) manufactured in Taiwan and

reselling them as a wholesaler to retailers in the United States. 

Petitioner commenced this business in 1987.

Ms. Michelle Chiou (Ms. Chiou) was petitioner's president

and chief executive officer during the years here in issue. 

Prior to the taxable year ending January 31, 1990 (fiscal year

1990), Ms. Chiou was petitioner's only employee. During its

fiscal year 1990, petitioner had one other employee. 

Petitioner's stock was owned half by Ms. Chiou and half by Alan

Chih-Kuo Tai.

Petitioner purchased garments from a number of suppliers in

Taiwan, one of which was Apollo Free Industrial Co., Ltd.

(Taiwan), a corporation formed under the laws of Taiwan (Apollo
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1 "Documented sales" represent garment sales, the sales

invoices for which can be matched with items in opening inventory

or items purchased during the year. "Deemed sales" are those

garment sales for which there are sales invoices but no matching

purchase invoices. "Imputed sales" are those garment sales of

items that were either included in opening inventory or purchased

during the year and did not appear in ending inventory, but for

which there are not complete matching sales invoices.

 

2 The sum of the purchase invoices for the fiscal year 1989

is $2,643,519.36. The parties disagree as to why this number

does not equal the amount in the stipulation, but both parties

apparently have agreed to use the number in the stipulation as

shown by this finding, despite the mathematical error.

 

3 Though the stipulation lists this figure as $107,190,

both parties have stated on brief that the correct figure is

$197,190.

Taiwan). Apollo Taiwan was owned by Ms. Chiou's father, Chiou

Wan-I.

For its fiscal year ending January 31, 1989 (fiscal year

1989), petitioner's gross sales of badges were $734,744 and its

cost of goods sold for these badges (excluding customs duties and

freight charges (CDFC)) was $566,176. For its fiscal year 1989,

petitioner's opening garment inventory was $171,762, plus CDFC in

the amount of $27,908. For that same year, gross sales of

garments was $3,713,466, which is composed of $1,398,151 in

documented sales, $1,397,100 in deemed sales, and $918,216 in

imputed sales.1 The above gross sales of garments is reduced by

$163,571 for damaged or missing imported goods. For its fiscal

year 1989, petitioner's garment purchases were $2,847,202, which

is composed of $2,650,012 in documented purchases2 and $197,1903

in imputed purchases. Petitioner's closing garment inventory for
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4 As in the computations for the taxable year ended Jan.

31, 1989, and as noted supra note 3, this figure does not

represent the sum of invoices introduced as evidence for that

year. As suggested by the parties, we find the amounts listed in

the stipulation of facts are appropriate.

its fiscal year 1989 was $311,452. Petitioner's cost of goods

sold for garments that year, excluding U.S. customs duties

(customs duties), freight charges, and incidental fees was

$2,707,512.

For its fiscal year 1990, petitioner's gross sales of badges

was $1,425,185 and its cost of goods sold for badges (excluding

CDFC) was $1,015,493. For its fiscal year 1990, petitioner's

gross sales of garments was $6,289,071, which is composed of

$3,554,018 in documented sales and $2,735,053 in imputed sales. 

The gross sales of garments is reduced by $2,476 for damaged or

missing goods. For its fiscal year 1990, petitioner's opening

garment inventory was $311,452. Garment purchases during that

year were $4,488,898, which is comprised of $4,223,566 in

documented purchases4 and $265,332 in imputed purchases. Closing

garment inventory was $219,232. Cost of goods sold for garments

for petitioner's fiscal year 1990 (excluding CDFC) properly

includable in inventory, was $4,581,118.

Mr. Roger Lee (Mr. Lee), the manager of Alexander Air

Express, Inc. (Alexander Air), prepared the customs documents for

petitioner during the years at issue. The shipping documents

were sent with the shipment if the shipment was by air, and, if
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the shipment was by sea, the shipper would send the shipping

documents to petitioner, and petitioner would provide these

documents to Alexander Air. Alexander Air then determined the

applicable U.S. customs duty rate for each item listed on each of

the shipping documents based on the rates shown in the Harmonized

Tariff Schedule of the United States, promulgated by the U.S.

International Trade Commission (the Harmonized Tariff Schedule). 

Mr. Lee determined the amount of customs duty by applying the

rate specified in the Harmonized Tariff Schedule for a specific

classification of product to the various items listed on

petitioner's purchase invoices for the years at issue.

The U.S. Customs Service (the Customs Service) inspected

petitioner's documents and shipments infrequently during the

years at issue. None of the few Customs Service inspections made

of petitioner's goods and documents during the years here in

issue resulted in changes in the amounts computed by Mr. Lee.

Customs duty rates applicable to imported items depend on

such variables as the type of fabric (e.g., knit versus woven),

the use of the garment (e.g., undergarment versus outergarment),

the country of origin, and the fabric composition (e.g., manmade

fiber versus all cotton versus cotton-polyester blend).

The freight charge made by Alexander Air for shipment of

goods to petitioner was based on volume, expressed in cubic

meters.
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Petitioner paid the invoices rendered by Alexander Air,

including freight charges and customs duties within 2 weeks to 1

month. Petitioner never failed to pay any amount owed to

Alexander Air, but on occasion, if Alexander Air was short of

cash funds, petitioner would pay the amount of the customs duties

directly to the Customs Service. Petitioner never paid customs

duties in excess of amounts computed by Alexander Air and shown

on the customs entry form.

Petitioner on its Federal income tax return for its fiscal

year 1989 deducted $398,900 of "duty & custom service" and

$33,318 for "freight & delivery". For its fiscal year 1990,

petitioner deducted $630,135 for "duty & custom service" and

$53,790 for "freight & delivery".

Respondent determined in her notice of deficiency that

petitioner received gross receipts in the amounts of $1,189,925,

$4,194,099, and $6,313,263 in lieu of $791,042, $3,739,433, and

$4,681,229 reported on petitioner's tax returns for its fiscal

years 1988, 1989, and 1990, respectively. Respondent also

determined that petitioner's costs of goods sold were in the

amounts of $757,582, $2,811,340, and $3,989,973, in lieu of

$752,044, $3,194,122, and $3,804,065 reported on petitioner's tax

returns for its fiscal years 1988, 1989, and 1990, respectively. 
- - 8

 

5 The parties have stipulated that petitioner is liable for

a deficiency in income tax in the amount of $4,818 for its fiscal

year 1988, and have further stipulated that petitioner is liable

for additions to tax pursuant to secs. 6651, 6653(a), and 6661

for that year. The parties have also stipulated that for its

fiscal year 1989, petitioner is not liable for an addition to tax

under sec. 6651, but that petitioner will be subject to an

addition to tax under sec. 6661 for its fiscal year 1989 if there

is a substantial understatement of tax as defined in sec. 6661(b)

for that year, and that petitioner is liable for an addition to

tax under sec. 6653(a) if petitioner is liable for an addition to

tax under sec. 6661. For its fiscal year 1990, the parties have

stipulated that petitioner is liable for an addition to tax under

sec. 6651, and that petitioner will be liable for an accuracyrelated penalty under sec. 6662(a) if petitioner would have had a

substantial understatement of income tax as defined in sec.

6661(b), had sec. 6661 still been in effect. 

The parties have also stipulated that the purchase and sale

of garments and badges is an income-producing factor within the

meaning of sec. 1.446-1(a)(4), Income Tax Regs.

Respondent in the statutory notice made no adjustment to CDFC

claimed as deductions by petitioner for the years here in issue.5

OPINION

The issue in this case is purely factual. In the three

stipulations for trial, the parties have agreed to all but two

facts necessary for the computation of gross income from sales by

petitioner for its fiscal years 1989 and 1990. The issue on

which the parties disagree is the amount of customs duties,

freight charges, and other import fees properly includable in the

cost of purchases, and in opening and closing inventory for

petitioner's fiscal years 1989 and 1990. The parties agree that 

customs duties paid by petitioner in each year, freight charges,

and other import fees paid by petitioner for delivery of the
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goods it purchased, are either a part of the cost of those

purchases, which increases the costs of goods sold and the value

on a cost basis of opening and closing inventories, or are

separately deductible items. The parties further agree to

consider those costs as a part of the cost of goods sold

(purchases) during each year and a part of the value on a cost

basis of goods in opening and closing inventories. If

petitioner's books and records were sufficient to clearly show

the amounts of these items, there would be no issue. However,

because of the inadequacy of petitioner's books and records, the

amounts of these items must be reconstructed. The parties differ

as to how this reconstruction should be accomplished. Additions

to tax and a penalty, if any, will be determined based on the

income resulting from the proper amount of customs duties and

freight charges to be included in cost of goods sold for each of

the years at issue.

The parties have agreed to make adjustments to customs

duties and freight charges by using the following method. 

Customs duties and freight charges for garments shall be the sum

of the customs duties and freight charges for purchases as shown

on the purchase invoices that correspond to documented sales or

are used to determine imputed sales. Customs duties and freight

charges for imputed purchases are to be at the duty rate and

freight cost applicable to the identical garment on which the

imputed purchase is based. Whether for garments or badges, the
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parties have agreed that the following rules apply: (1) Customs

duties and freight charges must be computed at the rates actually

in effect for the year involved, and (2) because customs duties

and freight charges are to be included in cost of purchases and

of goods in inventory, petitioner shall not be entitled to claim

these items as deductions.

For petitioner's fiscal year 1989, respondent and petitioner

disagree as to how customs duties should be calculated with

respect to documented sales. Petitioner contends that these

amounts should be determined by multiplying the amount of the

sales invoices provided in the record by the customs duty rate as

determined by petitioner's application on brief of the Harmonized

Tariff Schedule. Petitioner argues that these amounts result

from the method used by Mr. Lee, petitioner's customs agent,

during the years at issue, and the only witness who testified in

this case as to hypothetical examples. Respondent argues that

for those sales that are documented, the appropriate customs duty

rate should be determined by examining the customs rate as

calculated by Mr. Lee at the time the customs duties were paid by

matching documented sales with corresponding customs invoices. 

Petitioner essentially ignores the customs invoices.

After examining both petitioner's and respondent's

calculations, we conclude that respondent's method is a more

appropriate approximation of applicable customs duties with

respect to documented sales. We recognize possible
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inconsistencies in respondent's calculation, notably that

seemingly identical shipments are assigned substantially

different customs duties. However, the fact that the amount of

customs duties arrived at by petitioner's calculations is much

greater than either the amount reported on petitioner's returns,

or the amount calculated by Mr. Lee at the time the invoices were

prepared, indicates that petitioner's method of calculating the

appropriate customs duties overstates customs duties. On brief,

petitioner calculated that the total customs duties for its

fiscal years 1989 and 1990 were $792,121.09 and $1,194,213.13,

respectively. However, petitioner deducted on its Federal income

tax returns only $398,900 and $630,135, respectively, for its

fiscal years 1989 and 1990 for customs duties for both garments

and badges. 

We are convinced that the purchase invoices were properly

matched by respondent to the corresponding customs invoices. 

Therefore, the numbers on the customs invoices represent the

calculations made by Mr. Lee at the time the garments were

shipped. It was these amounts that petitioner actually paid as

customs duties with respect to the documented sales for which the

record permits a matching with customs duties invoices. These

are the amounts properly includable in petitioner's cost of goods

purchased or inventories as customs duties costs.

There is some evidence in the record to indicate that not

all items were subject to customs duties that may explain some of
- - 12

 

6 Respondent discarded two purchase invoices in her

calculation because the duty rates were .22% and 48.43%, which

were in amounts outside the normal range of other invoices.

the disparity in petitioner's and respondent's calculations. The

correctly matched invoices, as heretofore noted, represent

amounts actually paid by petitioner. Mr. Lee testified that

petitioner never paid customs duties in excess of the amount on

the duty form. The fact that these amounts represented accurate

customs duties is supported by Mr. Lee's testimony that the

Customs Service, during the years here in issue, never

disapproved the duty charges as computed by Mr. Lee. Based on

all of this evidence, we adopt respondent's calculations for the

customs duties on documented sales on those items on which the

duty charges can be matched with the correct invoices for garment

sales with regard to the 1989 fiscal year.

Respondent could not match the deemed sales with customs

invoices. Respondent applied the lowest applicable rate from the

matched duty charges to arrive at the amount she considered

appropriate customs duties for deemed sales. Respondent applied

the following rates:6

Garment Percentage

Mens T/R/C jeans 14.17%

Boys T/R/C jeans 14.05

Mens 100% acrylic sweater 11.86

Ladies 100% cotton jeans 11.86

Ladies T/R/C jeans 16.46

Boys/kids 100% cotton jeans 11.86
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Petitioner has applied the Harmonized Tariff Schedule rates to

deemed sales to calculate the appropriate percentage. Petitioner

states that this computation is based on the testimony of Mr.

Lee. Examples of these rates are as follows:

Garment Percentage

100% cotton jeans 17.7%

T/C jeans with PVC belt 29.7

Men's T/R/C 39% polyester,

 24% rayon, 37% cotton

 woven jeans 29.7

Men's T/C shorts, 65%

 polyester, 35% cotton 29.7

Men's T/R/C jeans 29.7

Boy's 100% acrylic sweater 34.2

After an examination of the purchase invoices and customs 

invoices in this case, it is clear that neither method 

appropriately estimates the customs duties applicable to those

purchase invoices that cannot be matched with customs invoices. 

Many of the purchase invoices list multiple garments that makes

it inappropriate to use those invoices to determine the rates of

customs duties for the items in deemed sales. Petitioner's

method as to deemed sales is unreliable for the same reasons it

is with respect to documented sales. An analysis of the 63

purchase invoices reveals 3 invoices that list only "Mens T/R/C

jeans", and 1 invoice which lists "Boys T/R/C jeans". The

invoices for men's jeans provide rates as follows:
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 Invoice Purchase Duty 

 date price Charge Rate 

 3/19/88 $44,800 $11,816.04 26.38% 

 4/02/88 33,232 5,150.81 15.50 

 4/30/88 52,987 7,510.20 14.17

 Total 131,019 24,477.01 18.68 

The 3 invoices that list only "Mens T/R/C jeans" show an average

customs duty rate of 18.68 percent. The sole invoice that listed

only boy's T/R/C jeans, invoice dated June 25, 1988, shows a

customs duty rate of 17.87 percent. For those items that cannot

be matched with duty charges, we hold that the rate for men's

T/R/C jeans is 18.68 percent, and the rate for boy's T/R/C jeans

is 17.87 percent. For the remaining invoices, including invoices

with multiple garments, we hold that the appropriate duty rate is

17 percent, based on approximations from various invoices. See

Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

Based on the calculations for both documented sales and

deemed sales, we hold that petitioner is entitled to a customs

duty rate of 17 percent for imputed sales.

Respondent maintains that petitioner is entitled to no

inclusion as part of cost of goods sold or deductions for customs

duties and charges with respect to badges. Respondent contends

that there is no evidence in the record to indicate that

petitioner incurred any customs duties whatsoever for its badge

sales, relying primarily on the testimony of Mr. Lee that some

items were "duty free". Petitioner relies on one invoice
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subsequent to the years at issue to show that the badges sold

were subject to customs duties and freight charges. Petitioner

further relies on the Harmonized Tariff Schedule to determine the

applicable percentages for badge sales.

The evidence shows that petitioner imported cloth badges

from Taiwan. The evidence further shows the amount of gross

sales and cost of goods sold other than customs duties, freight

charges, and other fees for the badges. It is also evident that

customs duties were charged to badge shipments in years after the

years here in issue. From this evidence, and relying somewhat on

the testimony of Mr. Lee, we conclude that customs duties and

freight charges were paid with respect to badges during the years

at issue. Petitioner contends, as with the garment sales, that

we simply multiply the sales price of the badges by the rate

shown on the Harmonized Tariff Schedule. Since there are two

rates that petitioner contends could be applicable from the

Harmonized Tariff Schedule, 8.4 percent for 100-percent rayon

woven embroidered badges with visible ground, or 16 percent for

100-percent rayon woven embroidered badges without visible

ground, petitioner has applied an average rate of 12.2 percent,

which calculates to customs duties allowable of $69,073.47 and

$123,890.14, for its fiscal years 1989 and 1990, respectively. 

However, petitioner deducted on its tax returns only $33,318 and

$53,790 for freight and delivery of badges for its fiscal years

1989 and 1990, respectively. There is no separate deduction for
- - 16

customs duties. Based on the evidence, we conclude that

petitioner's method of determining customs duties for badges

yields too high an amount. The Harmonized Tariff Schedule showed

percentages for customs duties for badges that were substantially

lower than percentages for garment sales. Based on the limited

evidence before us, we conclude that petitioner is entitled to a

4-percent customs duty for badges in 1989. 

Respondent has allowed freight charges for petitioner's

fiscal year 1989 as shown for those shipments on invoices that

can be properly matched. For the invoices that cannot be

matched, respondent has credited petitioner with freight charges

of only the $65 entry service fee, on the basis that the other

fees and charges varied widely.

Petitioner contends that a much higher amount for freight

charges is appropriate. Relying on an invoice from a later year,

petitioner contends that freight charges should equal 5.4 percent

of the value of the shipments for the years here in issue. 

Petitioner argues that total freight charges allowed for the

fiscal year 1989 should be $184,322.41. In addition, petitioner

maintains that it should be allowed to claim a formal entry fee

of $65 per shipment as part of cost of goods sold, as well as a

merchandise processing fee charged by the Customs Service in the

amount of .17 percent of the value of the merchandise. Finally,

petitioner contends that it should be allowed to claim the formal
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7 This table does not include invoices dated June 23, 1988,

and Sept. 19, 1988, because the freight charges on these invoices

were well outside the normal range (15.49% and .09%). These are

the same invoices mentioned supra note 6.

surcharge fee charged by the Customs Service of $3 per shipment,

for a total of $196,721.15.

For documented sales, we allow petitioner freight charges as

shown on the matched customs invoices and as determined by

respondent. For those sales that are not documented, we hold

that petitioner is entitled to both the $65 customs entry service

fee and the $3 formal surcharge fee charged by the Customs

Service. There is no evidence for us to conclude, as petitioner

contends, that the freight charges for the one shipment in 1990

upon which petitioner relies should be the basis for imputing

freight charges to the shipments for the years before us. This

is particularly evident in light of the variation in the

percentage of freight charges for those purchases that can be

matched with the appropriate customs invoices. The following is

a list of those purchase invoices and customs invoices that

respondent could match and the corresponding percentage of

freight charges, including all fees:7
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 Shipment Total purchase Freight 

 date price Charge Percent

 2/6/88 $53,416.00 $1,647.33 3.08% 

 2/26-27/88 72,670.00 1,815.00 2.50 

 3/19/88 44,800.00 1,880.00 4.20 

 3/26/88 80,345.36 1,840.00 2.29 

 4/2/88 33,232.00 883.28 2.66 

 4/9/88 53,507.20 1,632.33 3.05 

 4/30/88 52,987.00 1,270.10 2.40 

 5/14/88 83,116.00 2,228.00 2.68 

 5/30/88 81,807.36 2,325.00 2.84 

 6/4/88 61,866.30 1,326.65 2.14 

 6/25/88 81,915.60 1,298.10 1.58 

 7/16/88 149,104.96 2,376.00 1.59 

 7/30/88 17,240.40 554.58 3.22 

 8/6/88 145,539.80 3,129.50 2.15 

 8/19-20/88 93,106.25 2,033.00 2.18 

 8/27/88 72,730.50 1,675.00 2.30 

 8/27-9/3/88 63,720.60 1,530.50 2.40 

 10/1/88 94,337.30 3,095.50 3.28 

 10/8/88 29,373.30 1,201.00 4.09 

 10/15/88 104,538.00 1,975.00 1.89 

 10/22/88 105,118.00 2,032.00 1.93 

 11/5-11/88 98,051.10 3,640.00 3.71 

 11/19/88 119,324.56 3,579.50 3.00 

 11/26/88 128,622.78 3,645.00 2.83 

 Total 1,920,470.37 48,612.37 2.53

As is evident from the table, nearly all of these invoices

show freight charges of between 1.5 and 3.5 percent of the total

purchase price. On average, the ratio of freight charges to

purchase price was 2.53 percent. For both deemed and imputed

sales, we allow 2 percent of the total purchase price of the

shipments for these items, taking into account that we have

already allowed the customs entry service fee and the formal

surcharge fee. The freight charges were computed on the volume

of the shipment and not its value. However, there is no basis in
- - 19

this record other than a percent of value on which to estimate

the freight charges.

For the fiscal year 1990, there are no customs invoices from

Alexander Air that match purchase invoices to determine the

appropriate customs duties for either garments or badges. There

are only purchase invoices for that year. For 1990, respondent

has applied to each garment imported the lowest effective duty

rate that respondent calculated from 1989 that applied to the

same type item. For freight and import charges, respondent

applied a ratio of 1.99 percent. Respondent allowed no amount

for customs duties for badges for petitioner's fiscal year 1990. 

Petitioner applied the same method for each category of items for

its fiscal year 1990 that it applied for its fiscal year 1989. 

The record suggests that customs duties and freight charges were

the same for the same item for petitioner's fiscal year 1990 as

for its fiscal year 1989. We, therefore, conclude that the

percentages for petitioner's fiscal year 1990 would not be

substantially different from those for its fiscal year 1989. We

hold that petitioner is entitled to a 17-percent customs duty

charge for all garments and a 4-percent customs duty charge for

badges for its fiscal year 1990. We hold that petitioner's

freight charges fees for its fiscal year 1990 were the same as

for its fiscal year 1989, and that its freight charges for its

fiscal year 1990 were 2 percent of the total purchase price,

which is the same as for its fiscal year 1989. 
- - 20

Petitioner devotes much of its brief to argument that it is

being penalized because of its lack of adequate records. 

However, the duty is on petitioner to maintain adequate records

and, in determining items affecting its income tax, the lack of

such records should weigh heavily against petitioner. 

Petitioner's computations in lieu of its records do not comport

with facts in the record or with reason. We have determined

amounts we consider very reasonable for customs duties, freight,

and other fees with respect to petitioner's sales in the years

here in issue based on the facts in this record. We consider

these amounts to represent reasonably the amounts paid by

petitioner in each year. However, the fact that it was necessary

to reconstruct the amounts paid by petitioner for customs duties,

freight charges, and other fees is due to petitioner's failure to

keep adequate records as required by statute.

Decision will be entered

under Rule 155.