Opinion ID: 441995
Heading Depth: 1
Heading Rank: 5

Heading: may a holding company utilize the corn products doctrine?

Text: 50 From these cases and others, the Government argues that corporate securities are ordinary assets under Corn Products only if purchased without an investment motive and as a necessary and integral act in the taxpayer's business. CTI, on the other hand, asserts that the true test for determining when an otherwise-capital asset is an ordinary one is simply whether the taxpayer acquired the asset with an investment or a business purpose. 51 The essence of the Government's position is that (1) the holding of securities and collection of dividends is not a business for tax purposes and (2) accordingly, a stock acquisition that simply protects the acquirer's ability to make future stock acquisitions cannot satisfy the Corn Products' requirement of a necessary and integral link to a business. In effect, the Government takes the position that a holding or investment company 25 that is not itself directly involved on an operational level can never have a business purpose. 52 We reject the Government's position and refuse to adopt a rule that would automatically preclude an investment or holding company from utilizing the Corn Products rule. Rather, we believe that a corporation that owns securities and collects dividends is in fact engaged in a business for certain tax purposes. The Government is undoubtedly correct when it asserts that Corn Products does not apply unless the taxpayer establishes a link between the holding of the asset in question and the taxpayer's business. 26 We do not think that it follows, however, that a pure holding company can never avail itself of the Corn Products doctrine. We need not determine the precise parameters of the Corn Products doctrine as applied to companies engaged in traditional investment activities. 27 We simply hold that Corn Products can apply, if the trier of fact is convinced that there was no investment purpose, 28 when a holding company acquires an asset as an indirect means of incurring what would otherwise be a deductible business expense. 53 This conclusion follows from an analysis of the cases in the Corn Products line. Although broader readings have been suggested, 29 under the most narrow formulation [of the Corn Products doctrine], an asset is ordinary only where the taxpayer's motive was to accomplish a result normally achieved by incurring a deductible expense. Javaras, Corporate Capital Gains and Losses, 1974 Taxes at 770. 54 In the source of supply cases, for example, corporate securities were acquired as an indirect expense in the purchase of raw materials. Direct expenses for the purchase of raw materials are, of course, deductible, as finished products are sold, because they are included in the cost of goods sold. See generally 4 B. Bittker, Federal Taxation of Income, Estates and Gifts p 105.4.1. See also Commissioner v. Bagley & Sewall, 221 F.2d 944 (2d Cir.1955) (securities purchased to be held in escrow as security for taxpayer's obligations under contract). Hoover Co. v. Commissioner, 72 T.C. 206 (1979), is not to the contrary. 30 If CTI purchased the Supermarkets stock solely as a substitute for incurring a deductible expense, without a coexisting investment purpose, it necessarily had a business purpose under Corn Products. To answer the Government's contention that CTI could not have had a business purpose as a matter of law, we will assume the truth of CTI's claim that its sole purpose in acquiring the Supermarkets' stock was to protect its good will. We turn therefore to an analysis of whether a direct expenditure by CTI to protect its goodwill as an acquirer of businesses would be deductible. Whether the district court correctly determined that CTI's sole purpose was to protect its goodwill is discussed in Part V, infra. 55
56 The Government argues that a holding company is not engaged in a business. We think it is clear, however, that the tax meaning of the term business varies with the context in which it is used. Compare Asiatic Petroleum Co. v. Commissioner, 79 F.2d 234 (2d Cir.1935) (pure holding company is engaged in business for purpose of statute authorizing Commissioner to allocate income and deductions among trades or businesses controlled by the same interests) with Goodyear Investment Corp. v. Campbell, 139 F.2d 188 (6th Cir.1943) (holding company not carrying on or doing business for capital stock tax purposes). The Government has simply chosen to rely on those cases that express the meaning of business that suits its purpose on this appeal, without regard to the context in which the meaning was assigned. 31 We find those cases inapposite. 57 As we have said, the important context here, because it defines the boundaries of the narrowest formulation of the Corn Products doctrine, is the business deduction section of the Code. See I.R.C. Sec. 162. For purposes of an ordinary and necessary business deduction, the business of a holding company 58 consists of conserving and protecting its holdings, influencing, or directing when it can, the management of the companies in which it holds stock, so as to increase the value of its holdings and the income to be derived therefrom, the collection of dividends, the advantageous disposition of stocks in companies with whose management it is not satisfied; or where it appears desirable to do so, and reinvesting the proceeds, etc. 59 Allied Chemical Corp. v. United States, 305 F.2d 433, 437 (Ct.Cl.1962) (fees expended by holding company to contest SEC plan to liquidate corporation in which it held stock; held, deductible as ordinary and necessary business expense). See also Alleghany Corp. v. Commissioner, 28 T.C. 298 (1957). Thus, although a holding company does not conduct a business for purposes of the repealed capital stock tax, it need not capitalize all of its expenditures. We think it beyond question that a holding company is entitled to expense its ordinary and necessary costs not linked to the acquisition of specific assets. See generally 1 B. Bittker, Federal Taxation at p 20.4.2. (It is clear ... that the cost of investment advice, custodial services, safe-deposit box rentals, and similar expenses are deductible under IRC Sec. 162 ... even if the [corporate] taxpayer invests only in capital assets and seeks long-term appreciation rather than current yield.). 60 Of course, it is not relevant that investment activities by individual taxpayers may not constitute a trade or business, for the tax law has long distinguished between individuals and corporations in this regard. Compare Whipple v. Commissioner, 373 U.S. 193, 202, 83 S.Ct. 1168, 1174, 10 L.Ed.2d 288 (1963) (investing is not trade or business for purposes of deducting business bad debt) and Higgins v. Commissioner, 312 U.S. 212, 216, 61 S.Ct. 475, 477, 85 L.Ed. 783 (1941) (Management of one's own securities is not a business for purposes of deducting ordinary and necessary expenses) with Allied Chemical Corp., 305 F.2d at 433 (corporation's investment activities constitute business). But see Moller v. United States, 553 F.Supp. 1071, 1 Cl.Ct. 25 (1982) (individuals' investment activities can constitute trade or business where more extensive than those in Higgins ). Higgins, of course, has been legislatively overruled by I.R.C. Sec. 212 which allows deductions by individuals for expenses incurred in activities engaged in for profit. It is, we think, significant that Congress did not find it necessary to include corporations within I.R.C. Sec. 212; the strong implication is that investment activities by a corporation do constitute a trade or business. See 1B Bittker, Federal Taxation at p 20.1.2. (As for corporations, the fact that Congress did not include them in IRC Sec. 212 suggests the possibility that the term 'trade in business' as used by IRC Sec. 162 was thought to be broad enough to embrace a corporation's activities in managing its own investments.). 61
62 We turn, therefore, to an analysis of whether an expenditure by CTI to protect its goodwill and reputation would have been deductible as a business expense if it had not been accomplished indirectly through the acquisition of an otherwise-capital asset. It is clear that an expenditure to acquire goodwill must be capitalized. See, e.g., Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8, 78 L.Ed. 212 (1933) (expenditures to develop goodwill and reputation for taxpayer's new business; held, not deductible, but must be capitalized). It is equally clear, at least with respect to operating companies, that expenditures made to protect existing goodwill are deductible as ordinary and necessary business expenses under I.R.C. Sec. 162. See, e.g., Lutz v. Commissioner, 282 F.2d 614, 615 (5th Cir.1960) (payments to protect credit and standing in the industry); L. Heller & Son, Inc. v. Commissioner, 12 T.C. 1109 (1949) (taxpayer's payments in satisfaction of bankrupt subsidiaries' debts deductible as business expenses because made to protect taxpayers' reputation in business community). None of these cases involves the protection of the goodwill or reputation of a company whose sole activity is the acquisition of capital assets. We see no reason, however, to single out such companies for special treatment. 63 The Government correctly points out that expenses incurred in the investigation of potential acquisition candidates are not deductible as current expenses, but must be capitalized with the cost of the capital asset acquired. See, e.g., Ellis Banking Corp. v. Commissioner, 688 F.2d 1376 (11th Cir.1982), cert. denied, --- U.S. ----, 103 S.Ct. 3537, 77 L.Ed.2d 1388 (1983) (expenditures for investigation of corporation in connection with proposed acquisition; held, not deductible as ordinary and necessary business expense). Said the court in Union Mutual Life Insurance v. United States, 570 F.2d 382 (1st Cir.), cert. denied, 439 U.S. 821, 99 S.Ct. 87, 58 L.Ed.2d 113 (1978): 64 Thus, the authorities clearly indicate that expenditures made with the contemplation that they will result in the creation of a capital asset cannot be deducted as ordinary and necessary business expenses even though that expectation is subsequently frustrated or defeated, as was the case here. 65 Id. at 382 (emphasis in original) (fees expended by real estate investor to evaluate investment opportunities; held, not currently deductible). In Central Texas Savings & Loan v. United States, 731 F.2d 1181 (5th Cir.1984), we applied this rule and held that expenditures made in investigating and establishing new branches of a savings and loan association must be capitalized. 66 The Government argues from these cases that direct expenditures by a holding company to protect its goodwill as an acquirer of businesses must also be capitalized. Therefore, the argument runs, stock purchased for the same purpose (though without an investment motive) is not eligible for Corn Products treatment. 67 We do not think that these cases support that proposition. They involve expenditures for investigation of the possible acquisition of specific capital assets. They do not involve general expenditures that enhance the company's overall ability to make acquisitions. In fact, the court in Union Mutual Life Insurance, 570 F.2d at 382, expressly recognized this distinction and noted that payments made as salaries to regular employees for the everyday analysis of potential investments, for example, may well warrant different tax treatment. Id. at 382 n. 8. But compare Rev.Rul. 73-580 (corporation's salary payments to employees working on acquisitions and mergers must be capitalized; may be deducted as loss under I.R.C. Sec. 165 if merger or acquisition plan is abandoned) with Young & Rubicam, Inc. v. United States, 410 F.2d 1233, 1241, 187 Ct.Cl. 635 (1969) (salaries paid to employee for investigating possible expansion into foreign markets through subsidiaries; held deductible). 68 We think that the Supreme Court has made this distinction important. In Commissioner v. Lincoln Savings & Loan, 403 U.S. 345, 91 S.Ct. 1893, 29 L.Ed.2d 519 (1971), the Court delineated the difference between capital expenditures and deductible expenses: What is important and controlling, we feel, is [whether] the ... payment serves to create or enhance ... what is essentially a separate and distinct asset. Id. at 354, 91 S.Ct. at 1899. 32 The cases cited by the Government, denying deductions for investment-related expenses, are entirely consistent with Lincoln Savings: the expenses at issue were linked to separate and distinct capital assets. E.g., Central Texas Savings & Loan, 731 F.2d at 1181 (new branch offices); 33 Ellis Banking Corp., 688 F.2d at 1376 (corporate stock); Union Mutual Life Insurance, 570 F.2d at 382 (real estate developments). These cases do not, however, answer the question before us: whether a general expense, not related to a specific asset, that enhances a holding company's overall ability to make capital acquisitions is deductible. 34 69 We have not been cited to a case that answers this specific question and our independent research has revealed none. We see no principled reason, however, for exempting holding and investment companies from the established rule that expenditures for the protection of existing goodwill are currently deductible. 35 Clearly, had CTI made direct expenditures that simply protected its existing goodwill as an acquirer of businesses, it would not have acquired a separate and distinct asset within the meaning of Lincoln Savings. Moreover, even the cases that hold that investigation expenses must be capitalized recognize that, if a capital acquisition does not ultimately come to pass, the expenses are deductible as ordinary losses in the year the investment project is abandoned. E.g., Union Mutual Life, 570 F.2d at 393. This strengthens our conclusion that, absent a link to a specific asset, general expenditures for protection of goodwill, though it is goodwill that impacts solely on the ability to make future investments, are deductible as ordinary and necessary business expenses. 70 We are aware of the authority holding that, with respect to expenses incurred by individuals for the investigation of capital acquisitions that do not come to pass, an I.R.C. Sec. 165 loss deduction is only available if the acquisition process has proceeded beyond the preliminary stage and has focused on a specific asset. Otherwise, general investigation costs are personal expenses which are not deductible. See Bick v. Commissioner, 37 T.C.M. 1591 (CCH) (1978) (deduction denied for individual's expenses in investigating foreign investment opportunities because (1) no Sec. 162 trade or business; (2) merely preparatory; investment process not sufficiently advanced for Sec. 165; (3) no property interest for Sec. 212); Frank v. Commissioner, 20 T.C. 511 (1953) (same); Rev.Rul. 77-254 (individual's advertising expenses incurred in general search for businesses to acquire not deductible; legal fees incurred in drafting purchase agreement for acquisition that failed are deductible). These authorities denied deductions because the individual taxpayer-investors were not, under Higgins, engaged in a business and, until the search for capital acquisitions focused on a specific asset, had not engaged in a transaction for profit. They in no way cast doubt on our conclusion that a holding company, which is engaged in a business for purposes of deducting expenses, may deduct its general expenses, not linked to a specific asset, that enhance its overall ability to make capital acquisitions. 71 What we have said thus far does not, of course, mean that CTI's purchase of the Supermarkets stock is automatically qualified for Corn Products treatment. We have engaged in the analysis above simply to demonstrate that, assuming the truth of CTI's claims, this acquisition by this taxpayer is not automatically disqualified from Corn Products treatment. As we have said, a taxpayer that has allegedly acquired an otherwise-capital asset as an indirect means of incurring a deductible business expense is not, as the Government suggests, automatically precluded from asserting that Corn Products applies, simply because the taxpayer is engaged solely in investment activities. Rather, such a taxpayer, if his claims are proven, necessarily had a business purpose. Because CTI has alleged, in effect, that it purchased the Supermarkets stock as a substitute for incurring a business deduction, it is entitled, like any other taxpayer, to an opportunity to convince the fact finder that it has met the Corn Products test. We turn therefore to an analysis of the test of the Corn Products exception to capital asset treatment. 72