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MS-Puerto Rico reported a 1991 combined taxable income of
$102,551,316 attributable to the covered sales of diskettes
manufactured in Puerto Rico to unrelated third parties and foreign
affiliates. After applying the profit-split method, MS-Puerto Rico
reported its 1991 taxable income to be $51,275,658. As a
consequence of MS-Puerto Rico's profit-split method election and
computation of the combined taxable income, petitioner reported
$102,551,316 as combined taxable income and claimed a $51,275,658
combined taxable income deduction on its 1991 consolidated Federal
corporate income tax return.
Examination of Petitioner
Respondent conducted an examination of petitioner's 1990 and
1991 Federal corporate income tax returns which lasted more than 3
years. During this audit, respondent issued information document
requests (IDR's). Approximately 30 of these IDR's sought
information pertaining to MS-Puerto Rico's software duplication
operations and the prices charged to petitioner by uncontrolled
software duplicators. Another six IDR's requested information
pertaining to how MS-Puerto Rico calculated the combined taxable
income for purposes of applying the profit-split method.
On August 29, 1995, respondent issued Form 5701, Notice of
Proposed Adjustment (NOPA), which proposed to disallow MS-Puerto
Rico's election of the profit-split method. The NOPA indicated
that MS-Puerto Rico did not qualify for the profit-split method
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