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their independent third-party subcontractors performed services
with respect to some of the inventions. Engineering Systems
Corp. (ESC) was formed under the laws of California on April 4,
1974. Although ESC was initially owned by petitioner, during the
years in issue it was a wholly owned subsidiary of A-Alpha. ESC
received all of its revenue during the years in issue from A-
Alpha or A-Alpha's subsidiaries. ESC billed A-Alpha at cost plus
5 percent. Petitioner was the chairman of ESC's board of
directors.
The limited partnerships reported income on the cash basis
of accounting using a calendar year. A-Alpha and all of its
subsidiaries used a fiscal year ending March 31. A-Alpha and its
Hong Kong subsidiaries used the Hong Kong completed contract
method of accounting, which recognized income and expenses in the
year in which the contractor concluded it had completed the
contract.7 ESC filed Federal income tax returns during the years
in issue and reported its income using an accrual method of
accounting. ESC's financial statements indicate that it incurred
net losses of $1,586,451, $2,105,687, and $13,816 during the
years 1978 through 1980, respectively, and $1,074,613 for the
period beginning April 30, 1974, and ending March 31, 1977.
A-Alpha subcontracted all of the research and development to
its Hong Kong and U.S. subsidiaries and to independent
7 Such determination was without regard to whether other
parties to the contract considered the contract fully performed.
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