Source: http://openjurist.org/597/f2d/395/jacks-cookie-company-v-united-states
Timestamp: 2017-04-29 18:11:21
Document Index: 697650191

Matched Legal Cases: ['§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 1346', '§ 1402', '§ 6', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 162', '§ 1221', '§ 12', '§ 167', '§ 461', '§ 461']

597 F2d 395 Jack's Cookie Company v. United States | OpenJurist
597 F. 2d 395 - Jack's Cookie Company v. United States HomeFederal Reporter, Second Series 597 F.2d.
597 F2d 395 Jack's Cookie Company v. United States 597 F.2d 395
79-1 USTC P 9350
JACK'S COOKIE COMPANY, Appellee,v.The UNITED STATES of America, Appellant.
No. 77-2210.
Argued Dec. 5, 1978.Decided April 25, 1979.
Challenging the disallowance, taxpayer argues that even though the reserve payments might benefit Jack's by fulfilling certain provisions of the lease beyond the tax year in issue, the lessee had no choice but to make the monthly payments into the reserve if it was to enjoy continued use of the industrial building during the tax year; failure to do so would have allowed the county to cancel the lease. Thus, it is contended, the payments constituted ordinary and necessary business rental expenses deductible in the year paid under the plain language of Section 162(a)(3) of the Internal Revenue Code, 26 U.S.C. § 162(a) (3), which reads:
In computing taxable income, a business is authorized by Section 162(a)(3) of the Internal Revenue Code to deduct "rentals" from its gross income. Although the term "rentals" is not defined in the statute, as early as 1925 the Supreme Court recognized that the word is to be taken in its "usual and ordinary sense" to mean "a fixed sum, or property amounting to a fixed sum, to be paid at stated times for the use of property." Duffy v. Central R.R., 268 U.S. 55, 63, 45 S.Ct. 429, 431, 69 L.Ed. 846 (1925). This interpretation of "rentals," which has never been legislatively altered, has been consistently followed by the courts, although not without elaboration.
Notably, it has been firmly established as a result of litigation under § 162(a)(3) that, to qualify as a rental, a payment made to secure the use of business property must be "required" of the lessee, or, as put by one court, "wrung from (the lessee) by compulsion of circumstances delineated by law." Utter-McKinley Mortuaries v. Commissioner, 225 F.2d 870, 874 (9 Cir. 1955). As an essential attribute of rentals, the compulsion to pay is most often discussed in the context of contrived arrangements between lessors and lessees which have as their evident purpose the evasion of taxes,14 but it is nevertheless a characteristic which, as a common sense matter, any claimed "rental" expenditure must possess if it is to be treated as such for purposes of an expense deduction. To hold otherwise would be to invite the deduction as rent of sums which are not truly paid "for the use of property," in contravention of the settled principle that statutes authorizing deductions from income for federal tax purposes are to be strictly construed. See Koerner v. United States, 550 F.2d 1362 (4 Cir. 1977), Cert. denied, 434 U.S. 984, 98 S.Ct. 608, 54 L.Ed.2d 477 (1977). Thus, unless a taxpayer is under an obligation to compensate another in return for the use of property for business purposes, the disbursement is not a "rental" under § 162(a)(3).
The same is true of the "other payments" related to the lease of property for which deductions are authorized by this section of the Code payments "Ejusdem generis with 'rentals,' such as taxes, insurance, interest on mortgages, and the like, constituting liabilities of the lessor on account of the leased premises which the lessee has covenanted to pay." Duffy v. Central R.R., supra, 268 U.S. at 64, 45 S.Ct. at 431. In express terms, the statute allows a taxpayer to subtract such outlays in arriving at taxable income only if they are "required to be made as a condition to the continued use or possession" of the property.
But although an "obligation to pay" must exist before a business will be allowed to deduct a lease-related payment under § 162(a)(3), it does not follow that all expenditures which a business is compelled to make in order to secure the use of property constitute "rentals" or "other payments," or that those which facially qualify as such are deductible in the year paid. That a business is "required" to incur an expense to avoid cancellation of a lease, or as the court below stated, that "(t)here is no way (the taxpayer) can get the land without making the payments as required," goes only to the threshold factual question of whether the expenditure is of the sort contemplated by subsection (3) of § 162(a), and it is not dispositive of that issue, since there are other characteristics which a disbursement must have if it is to be treated as a "rental" or "other payment" within the meaning of the statute. Moreover, once it is determined that an expenditure Is by nature a "rental" or "other payment," and the inquiry then turns to the matter of When a § 162(a)(3) deduction in that amount may be taken, the fact that a taxpayer was "required" by the lease to pay the sum at a particular time is of less significance and does not of itself warrant allowance of the deduction in any particular year.
Not often advanced in explicit terms, these principles are plain from the face of the "decided cases" referred to in the opinion below. If it were true, for example, that by reason of their mandatory nature all payments extracted by contract as a condition to occupying another's property qualify as "rentals" or "other payments" under § 162(a)(3), then one would expect that a "security deposit" paid by a business as a prerequisite to possession of premises, and sums periodically paid to continue the possession, would be uniformly treated as such. Yet as the decision in Minneapolis Security Building Corp. v. Commissioner, 38 B.T.A. 1220, 1224 (1938), demonstrates, such status may be denied a security deposit which a business is "required" to pay at the outset of a lease, and the cases are legion which on various grounds have refused to treat as statutory "rentals" or "other payments," installments, though labelled "rent," remitted to the owner of property by a taxpayer business in fulfillment of the strict terms of a written lease. E. g., Duffy v. Central R.R., supra, 268 U.S. 55, 45 S.Ct. 429, 69 L.Ed. 846 (rejecting the argument that any payments under a lease, the failure to make which would entitle the landowner to terminate the possession of the property, constitute "rentals" under the statute); Foyt v. United States, 561 F.2d 599 (5 Cir. 1977) (monthly "rental payments" were in fact contributions to capital, not rentals); M & W Gear Co. v. Commissioner, 446 F.2d 841 (7 Cir. 1971) (claimed "rentals" held instead to be partial payments on purchase price); West Virginia Northern R. Co. v. Commissioner, 282 F.2d 63 (4 Cir. 1960), Cert. denied, 366 U.S. 929, 81 S.Ct. 1650, 6 L.Ed.2d 388 (1961) (sums designated "rentals" by lease were actually payments in satisfaction of personal debt). Obviously, something more than the compulsory nature of a disbursement determines whether or not it qualifies for deduction under the statute.
Similarly, a "requirement to pay" cannot explain the results in cases where the issue has been the Timing of deductions for sums which Do qualify as "rentals" or "other payments." Although incurred in each instance pursuant to contract, some costs of this kind like the elements of plaintiff's rent which are defined in terms of principal, interest, and administration expenses are commonly allowed as deductions in the year they fall due, while others, notably "advance" or "prepaid" rentals, are often allowed as deductions only in or over some later period.15 For cases of the latter kind, See n. 8, Supra. The only legitimate explanation for these differences is that the matter of when a deduction may be claimed under § 162(a)(3) is not determined solely on the basis of whether, under threat of penalty or dispossession, the lessee was bound to remunerate the lessor in a given amount on a certain date. The pertinent inquiry is of wider scope.
We conclude, therefore, that the brief rationale offered by the court below does not sustain the judgment on appeal. To qualify for a current deduction under § 162(a)(3) of the Code, it is necessary, but not sufficient, that an outlay made during the tax year was "required" of the lessee as a condition to occupancy of the premises. While Jack's no doubt would have risked cancellation of the lease had it not timely forwarded the "reserve payment" portion of the monthly installments to the trustee, this circumstance satisfies only one element of the claim for relief, and is not, in itself, dispositive under either the taxpayer's or the Government's theory of the case.
The one-year concept surfaced again in Darlington-Hartsville Coca-Cola Bottling Co. v. United States, 393 F.2d 494 (4 Cir. 1968), Cert. denied, 393 U.S. 962, 89 S.Ct. 402, 21 L.Ed.2d 376 (1968). There the taxpayer bottling companies deducted in one year, as an ordinary and necessary business expense under § 162(a), amounts they had paid the owner of a soft drink franchise to eliminate a middleman syrup distributor. Elimination of the middleman reduced the price of syrup to the bottlers, and there was every indication that the taxpayers would enjoy this more profitable arrangement in future years at no additional cost. Citing Richmond Television, the district court upheld the Commissioner's determination that the amounts spent to acquire the new syrup contracts were capital investments despite the fact that the contracts were not physical assets in the technical sense.21 We adopted the opinion of the lower court with the observation that a capital expenditure is marked by "its intendment to produce a positive business benefit whose effects will be reaped in seasons beyond a single year." 393 F.2d at 496.
We last applied the one-year rule as an alternative ground for our decision in Georator Corp. v. United States, 485 F.2d 283 (4 Cir. 1973), Cert. denied, 417 U.S. 945, 94 S.Ct. 3069, 41 L.Ed.2d 665 (1974). In Georator, Which concerned the tax treatment of legal fees incurred by a corporation in successfully resisting the cancellation of a trademark registration, we stated that
Agreeing with the bank in its action for a refund, the district court noted, but did not rely upon, the one-year rule. Instead, it considered the facts of the case in the light of language from the Supreme Court's opinion in Commissioner v. Lincoln Savings and Loan Association, 403 U.S. 345, 91 S.Ct. 1893, 29 L.Ed.2d 519 (1971):
403 U.S. at 354, 91 S.Ct. at 1889, quoted in 413 F.Supp. 1107, 1111 (D.S.C.1976). Since the taxpayer's membership in the association was non-transferrable and, therefore, of no intrinsic value, with the result that the bank had no salable asset from which it could recoup its assessments, the district judge concluded that the assessments could not be regarded as creating for the bank "anything remotely similar to the 'distinct and recognized property interest' which the Court in Lincoln Savings found that the taxpayer had acquired." Id.
Although Jack's had to pay the reserve element of its monthly rents to continue in possession of the property, and in that sense the payments were of current consequence to the company, there is no doubt that the disbursements also secured to the taxpayer benefits having a useful life which extended substantially beyond the close of the taxable year. This is clear from the indenture of mortgage, which requires that the trustee credit Jack's with the amount in the reserve fund in the event of prepayment of rent, and that the trustee return to the fund any interest earned on the investment of the reserves, thereby increasing the size of this credit. The taxpayer makes the point that Jack's might default on the lease or that other circumstances might arise to prevent Jack's from receiving the benefit of the reserve, but we do not see that this possibility requires treatment of the payments as § 162(a) expenses. A similar argument was advanced by the taxpayer in Lincoln Savings, but the Court rejected it with the observation that "this hazard exists with any routine investment in a bank or an insurance company and yet its presence does not make that investment an expense rather than a capital undertaking." 403 U.S. at 357, 91 S.Ct. at 1900.
In Lincoln Savings the Court found that the reserve account into which the payment flowed was essentially a separate asset because it was "available for only stated and circumscribed purposes", because it was "more permanent than temporary", and because the taxpayer had a "distinct and recognized property interest" therein (interest earned on FSLIC's investment of taxpayer's contributions was credited to taxpayer's share of the reserve). 403 U.S. at 355-356, 91 S.Ct. at 1899; the same can be said of the reserve into which the disputed portion of Jack's monthly installments was paid. There, as here, the reserve into which the taxpayer paid premiums was statutorily mandated, but the Court noted that "the fact that a payment is imposed compulsorily upon a taxpayer does not in and of itself make that payment an ordinary and necessary expense within the meaning of § 162(a) of the 1954 Code." 403 U.S. at 359, 91 S.Ct. at 1901. There, too, it was unlikely that the taxpayer would ever recover its payments, but the Court deemed this fact of little significance and found that the bank could nonetheless benefit from its expenditure in the future. 403 U.S. at 357, 91 S.Ct. 1893. There the taxpayer, like Jack's, interposed the annual accounting concept of the income tax as a factor which required that a current deduction be allowed, but the Court viewed that argument as having little bearing upon "the determination of whether an item is or is not an ordinary expense." 403 U.S. at 358, 91 S.Ct. at 1901. On balance, there is little of significance to distinguish the two cases, and we discern nothing in Lincoln Savings which would entitle Jack's to a current deduction.
The company, which insists that the expenditures in question were "rentals," disclaimed at oral argument any reliance upon the "or other payments" language of the statute. Also, neither party contends that Jack's has taken or is taking title to the leased premises, or that Jack's has any equity therein within the meaning of Section 162(a)(3). Upon expiration of the 30-year term of the lease on August 1, 1992, taxpayer has the option to renew for three additional terms of 10 years each
The district court had jurisdiction of this action under 28 U.S.C. § 1346(a)(1), and venue was properly laid in the Western District of North Carolina because taxpayer maintained its principal place of business in that district. 28 U.S.C. § 1402(a)(2)
E. g., Sparks Nugget, Inc. v. Commissioner, 458 F.2d 631, 634 (9 Cir. 1972), Cert. denied, 410 U.S. 928, 93 S.Ct. 1362, 35 L.Ed.2d 589 (1973); Potter Electric Signal and Mfg. Co. v. Commissioner, 286 F.2d 200, 202-203 (8 Cir. 1961); Kirschenmann v. Westover, 225 F.2d 69 (9 Cir. 1955), Cert. denied, 350 U.S. 834, 76 S.Ct. 70, 100 L.Ed. 744 (1955); Smith v. United States, 278 F.Supp. 230, 232 (S.D.Tex.1968); E-Z Sew Enterprises, Inc. v. United States, 260 F.Supp. 100, 118-119 (E.D.Mich.1966). There is no suggestion that the "reserve payments" provision of the lease between Jack's and the county was contrived. Indeed, the county may have been bound by state law to establish some sort of reserve in light of the issuance of revenue bonds. See Tenn. Code Ann. §§ 6-1704(4), 1715
It is suggested in taxpayer's brief on appeal that if an expenditure meets the definition of "rental" for purposes of subsection (3) of § 162(a), then it need not also possess the characteristics of a "trade or business expense" under § 162(a) in order to constitute a deductible expense under § 162. See Brief of Appellee at 12, 17-18. However, the plain language of the statute refutes this argument, and we note that the courts have not observed this distinction. Deductions claimed for "rentals" often have been disallowed on the basis that the expenditures in question failed to pass muster under § 162(a). See, e. g., Foyt v. United States, 561 F.2d 599 (5 Cir. 1977); Perry v. United States, 520 F.2d 235 (4 Cir. 1975), Cert. denied, 423 U.S. 1052, 96 S.Ct. 782, 46 L.Ed.2d 641 (1976). Moreover, in recognizing and relying upon the notion that a sum must be "paid or incurred during the taxable year" in order to be treated as a "rental," Brief at 6, even the appellee acknowledges that § 162(a)(3) rentals must meet a requirement that is found only in § 162(a). Accordingly, we view the taxpayer's position to necessarily be that the reserve payments qualified as deductible expenses not only because they satisfied the specific conditions which any "rental" must meet under § 162(a)(3), but also because they met the basic tests of a § 162(a) trade or business expense, of which "rentals" are but one variety
This treatment of the expenditures follows from the principle that "(c) apital expenditures * * * if deductible at all, must be amortized over the useful life of the asset," Commissioner v. Tellier, 383 U.S. 687, 689-690, 86 S.Ct. 1118, 1120, 16 L.Ed.2d 185 (1966), and is akin to the treatment afforded "advance rentals" which, once they are recognized as "capital expenditures," may be subtracted in arriving at taxable income only in the year or years in which they are actually used to displace rental payments that the lessee would otherwise have to make during those periods under the lease. Although "an expenditure need not be for a capital asset, as described in Section 1221 of the Code, 26 U.S.C. § 1221, in order to be classified as a capital expenditure," Georator Corp. v. United States, 485 F.2d 283, 285 (4 Cir. 1973), Cert. denied, 417 U.S. 945, 94 S.Ct. 3069, 41 L.Ed.2d 665 (1974), "the reason for disallowing the deduction of the entire payment or obligation in the taxable year is that there is no provision which permits deduction (of a capital expenditure) other than that which allows depreciation or amortization over the useful life of the asset acquired." 2 J. Mertens, Law of Federal Income Taxation § 12.24 (1974 Revision). See 26 U.S.C. § 167. Appellee's reliance upon 26 U.S.C. § 461(a) to avoid this result is misplaced, since § 461(a) does not govern the timing of deductions for disbursements of a capital nature
Vacated and remanded on other grounds, 382 U.S. 68, 86 S.Ct. 233, 15 L.Ed.2d 143 (1965), On remand, 354 F.2d 410 (4 Cir. 1965)
Darlington-Hartsville Coca-Cola Bottling Co. v. United States, 273 F.Supp. 229 (D.S.C.1967)
" * * * however, the Court (in Georator ) assumed the existence of a definite asset, the trademark, and * * * (dismissed) taxpayer's argument that its legal fees should not be capitalized because they only maintained and did not enhance the value of the trademark. Georator was correctly decided, but it is not inconsistent with the result in this case, where neither party can identify or define any asset upon which taxpayer's assessment expenditures have had any effect."
First Nat. Bank of South Carolina v. United States, 413 F.Supp. 1107, 1112 (D.S.C.1976).