Opinion ID: 441995
Heading Depth: 2
Heading Rank: 2

Heading: Expenditures to Protect Goodwill as an Acquirer of Businesses.

Text: 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