Opinion ID: 343604
Heading Depth: 2
Heading Rank: 2

Heading: The Approval of the Section 482 Allocation

Text: 15 Continental's primary contention on this cross-appeal is that Section 482 and the pertinent treasury regulations make the payment of refunds to the related corporations a condition precedent to the allocation of interest income to Continental. We reject this view. 16 Section 482 authorizes the Commissioner to allocate income, deductions, credits, or allowances among commonly controlled enterprises where necessary (1) to prevent them from artificially shifting income and loss items among themselves to minimize their tax liability, or (2) to insure that the income of each related corporation is accurately reflected in its returns. South Texas Rice Warehouse Co. v. Commissioner of Internal Revenue, 366 F.2d 890, 898 n. 19 (5th Cir. 1966), cert. denied, 386 U.S. 1016, 87 S.Ct. 1370, 18 L.Ed.2d 454 (1967). Its purpose is to place controlled taxpayers in the same position as uncontrolled taxpayers for both the current and subsequent taxable years. Treas.Reg. § 1.482-1(b)(1) (1976); Commissioner of Internal Revenue v. First Security Bank of Utah, 405 U.S. 394, 401, 92 S.Ct. 1085, 1089-91, 31 L.Ed.2d 318, 324-325 (1975); Engineering Sales, Inc. v. United States, 510 F.2d 565, 569 (5th Cir. 1975). Because Section 482 is an allocation provision rather than a recognition provision, it does not authorize the Commissioner to augment or diminish the income of a group of related corporations when taken as a whole. 7 J. Doheny, Merten's Law of Federal Income Taxation § 38.63, p. 159 (rev. ed. 1976); B. Bittker & J. Eustice, Federal Income Taxation of Corporations & Shareholders, P 15.06, p. 30, n. 53 (3d ed. 1971). Accordingly, the treasury regulations require that whenever the income of one member of a group of commonly controlled corporations is increased (primary adjustment) the income of at least one of the others must be decreased a commensurate amount (correlative adjustment). Treas.Reg. § 1.482-1(d)(2) (1976). They describe in detail how this is to be done. 17 (T)he correlative adjustment shall actually be made if the U.S. income tax liability of the (related corporation) would be affected for any pending taxable year. . . . (A) pending taxable year is any taxable year with respect to which the U.S. income tax return of the (related corporation) has been filed by the time the allocation is made, and with respect to which a credit or refund is not barred by the operation of any law or rule of law. If a correlative adjustment is not actually made because it would have no effect on the U.S. income tax liability of the (related corporation) for any pending taxable year, such adjustment shall nevertheless be deemed to have been made for the purpose of determining the U.S. income tax liability of such (related corporation) for a later taxable year . . . . Id. 18 Under the regulations, the duty to make or deem made a correlative adjustment does not arise until one of five events has occurred. Treas.Reg. § 1.4821(d) (2)(i)-(v) (1976). Among these events, and controlling in this case because it happened first, is a stipulation by the parties that the reallocated income in question was properly imputed to the taxpayer. 19 As soon as the parties filed their stipulation in the Tax Court, the Commissioner became obligated either to make a correlative adjustment or to deem one to have been made. Although he did not discharge this duty immediately, he did act with reasonable promptness. Since the related corporations had neither filed refund claims nor submitted information sufficient to enable him to determine whether a correlative adjustment would affect their income tax liability for a pending taxable year, the Commissioner elected to deem a correlative adjustment to have been made. 20 The Commissioner's decision was neither arbitrary nor inconsistent with the regulations. The regulations authorize him to make a primary adjustment whether or not the related corporations are, or ever will be, in a position to realize potential tax benefits which may result from a correlative adjustment. In Fitzgerald Motor Co. v. Commissioner of Internal Revenue, 508 F.2d 1096 (5th Cir. 1975), we reviewed a Section 482 allocation of interest income resulting from loans made among three sister corporations. There we held that the regulations issued to implement Section 482 authorized the Commissioner to merely deem a correlative adjustment to have been made because the allocation of interest expense to the related corporations would only have increased the amount of their net operating loss available for carryover, and would not have affected their tax liability for any pending taxable year. Today's case is distinguishable from Fitzgerald in only one respect. Here, the Commissioner concluded that the tax liability of the related corporations would not be affected for a reason different from that relied upon in Fitzgerald: In Fitzgerald there was no income which the interest expense could reduce; in this case the claims of the related corporations which could translate the correlative adjustment into a tax refund are time-barred by Section 6514(a). 21 This distinction does not command a difference in result. The tax liability of a related corporation is no more or less affected by a correlative adjustment if its refund claim is untimely, than if it sustained a net operating loss during the pertinent taxable year. If a related corporation's refund claim is barred because it is untimely, then the potential tax benefit is lost; if it sustained a net operating loss during the pending taxable year, then the potential tax benefit is deferred, and it may be extinguished if net operating losses continue in succeeding tax periods. Thus, where the tax liability of a related corporation would not be affected by a correlative adjustment, the regulations as construed by Fitzgerald permit the Commissioner to attribute the reciprocal of the primary adjustment to it by deeming a correlative adjustment to have been made. It is not a prerequisite to a primary adjustment that the related corporation be in a position to avail itself of any potential tax benefit which may result from a correlative adjustment. 7 22 Nor do the regulations require the Commissioner to presume that a correlative adjustment will affect the tax liability of a related corporation for a pending taxable year. A taxpayer seeking a refund bears the burden of notifying the Commissioner that a refund is sought and of indicating the basis for the claim. National Newark & Essex Bank v. United States, 410 F.2d 789, 794, 187 Ct.Cl. 609, 618-619 (1969); cf. Stoller v. United States, 444 F.2d 1391, 1393 (5th Cir. 1971) (where a refund claim is filed, the Commissioner need examine only those points to which his attention is directed); Alabama By-Products Corp. v. Patterson, 258 F.2d 892, 900 (5th Cir. 1958), cert. denied, 358 U.S. 930, 79 S.Ct. 318, 3 L.Ed.2d 303 (1959); Treas.Reg. § 301.6402-2(b)(1) (1976). The regulations promulgated under Section 482 do not shift this burden to the Commissioner. See 2 J. Rabkin & M. Johnson, Federal Income, Gift & Estate Taxation § 11.02B(2), pp. 1119a-b (1976). 23 But Continental contends that Section 482 requires more than that the Commissioner comply with regulations. Its position is that the statute demands not only that a correlative adjustment actually be made, but also that a refund based on it be given before the primary adjustment can become final. Continental argues that if the regulations permit a primary adjustment to be made where the correlative adjustment is merely deemed to have been made and no refund is granted, they permit an invalid creation of income. 24 A taxpayer challenging the validity of a treasury regulation faces a difficult task. Since Congress has expressly delegated rulemaking authority to the Secretary of the Treasury, 26 U.S.C.A. § 7805(a) (1967); United States v. Cartwright, 411 U.S. 546, 550, 93 S.Ct. 1713, 1716, 36 L.Ed.2d 528, 533 (1973), treasury regulations are valid legislative rules if they are (a) within the granted power, (b) issued pursuant to proper procedure, and (c) reasonable. 1 K. Davis, Administrative Law Treatise § 5.03, p. 299 (1958) & § 29.01-1, p. 654 (Supp.1976); Yellow Freight System, Inc. v. United States, 538 F.2d 790, 796 (5th Cir. 1976). Since Continental does not assault the procedural foundation of the regulations, they must be sustained unless unreasonable and plainly inconsistent with the revenue statutes. Bingler v. Johnson, 394 U.S. 741, 749-51, 89 S.Ct. 1439, 1444, 22 L.Ed.2d 695, 703-704 (1969), quoting Commissioner of Internal Revenue v. South Texas Lumber Co., 333 U.S. 496, 501, 68 S.Ct. 695, 698, 92 L.Ed. 831 (1948); Fitzgerald Motor Co. v. Commissioner of Internal Revenue, 508 F.2d at 1100; see United States v. Cartwright, supra ; United States v. Correll, 389 U.S. 299, 306, 88 S.Ct. 445, 449, 19 L.Ed.2d 537, 543 (1967). Continental has not met this rigorous standard. The regulations allow the Commissioner to deem a correlative adjustment to have been made only where the Code does not authorize him to assess a deficiency against the related taxpayers, or to award them a refund or a tax credit. Thus the regulations operate to permit the Commissioner to make the adjustment necessary to prevent the artificial shifting of income among commonly controlled corporations resulting in tax avoidance and, at the same time, to accomplish the other purposes of Section 482: to insure that the income of commonly controlled enterprises is accurately reflected in their returns, and to place commonly controlled corporations in the same position as uncontrolled taxpayers for subsequent taxable years. There is nothing unreasonable in this and, indeed, it is plainly consistent with the statute. 25 Moreover, acceptance of Continental's argument that the implementation of the correlative adjustment through refunds to the related corporations is a condition precedent to a primary adjustment, would generate absurd results at odds with the purposes of Section 482. It would make the Commissioner's ability to effect a Section 482 allocation dependent upon whether the related corporations could qualify for refunds. Under such a rule, commonly controlled corporations could shift income and loss items among themselves for tax avoidance purposes with impunity whenever a Section 482 allocation would not result in a refund to a related corporation, or whenever a related corporation that might be eligible for a refund neglected to file a timely claim. To adopt Continental's suggestion would be tantamount to judicial repeal of Section 482.