Opinion ID: 2996789
Heading Depth: 2
Heading Rank: 2

Heading: Webb controls

Text: Next, we agree with the tax court that the facts of this straightforward case do not dictate a departure from Webb. In Webb, the taxpayer acquired a wood veneer company that many years ago agreed to pay an employee’s widow, Mrs. Grunwald, a lifetime pension of $12,700 annually. 708 F.2d at 1255. The taxpayer knowingly assumed the liability to Mrs. Grunwald as part of the purchase agreement. Id. In tax years thereafter it attempted to deduct, as an ordinary and necessary business expense, the $12,700 paid to Mrs. Grunwald. The Commissioner determined that the $12,700 was not an ordinary business expense, but a capital one, which the tax court upheld. Id. at 1255-56. We affirmed, observing that because the taxpayer agreed to assume the pension payments as part of its purchase agreement for the wood veneer business, the payments were more properly attributed to that capital investment, not its current business operations. Id. at 1256. In essence, the agreement to pay the debt to the widow served as part of the purchase price for the business. Id. (“Assumption of the obligation to make pension payments to Mrs. Grunwald was in theory and in fact, part of the cost of acquiring the assets of the wood veneer business from the taxpayer’s predecessor.”) Because the purchase of the wood veneer business was meant to enhance the taxpayer’s operations into the future, the expenses to acquire it—which included the discharge of the annual debt to Mrs. Grunwald—had to be 3 ITW argued for deductibility on several different grounds before the tax court, abandoning all but its reliance on Staley on appeal. 10 No. 02-1239 capitalized. Id. (stating that generally “when an obligation is assumed in connection with the purchase of capital assets, payments satisfying the obligation are non-deductible capital expenditures”). Similarly, ITW knowingly assumed the Lemelson lawsuit as part of the purchase agreement for the DeVilbiss assets. Because ITW agreed to pay that contingent liability in exchange for DeVilbiss, that contingent liability formed part of the purchase price. Because the DeVilbiss acquisition was meant to benefit ITW into the future, the expenses to acquire it—including the Lemelson lawsuit, once assigned a value through the judgment—must be capitalized. ITW attempts to distinguish Webb based on the parties’ expectation of the ultimate value of the Lemelson lawsuit and on ITW’s alleged ability, post-acquisition, to negatively impact the liability amount. In Webb, the acquiring company knew that it owed an annual liability of $12,700 and that it would end when Mrs. Grunwald passed. Therefore, ITW argues, the parties in Webb had a complete understanding of the scope of the contingent liability at stake in the deal, unlike in the case before us where the parties to the transaction failed to grasp the risk represented by the Lemelson lawsuit. ITW also urges that since the taxpayer in Webb could do nothing to affect the amount of the liability, unlike here where the failure to accept a settlement offer increased the debt exponentially, Webb should be ignored. ITW’s attempts to distance itself from Webb are unavailing. ITW agreed to assume the Lemelson defense and pay any judgment, whatever it may be. Although we have no doubt the parties earnestly believed the case was meritless, ITW cannot dispute that it acknowledged some risk, albeit minimal, and did not take steps to mitigate that risk. It could have lowered the purchase price or inserted an No. 02-1239 11 indemnification clause in the purchase agreement to recoup any losses not anticipated by the parties. That a contingent liability, once fixed, exceeded the parties’ expectations does not render it any less a part of the purchase price. See Pacific Transport Co. v. Commissioner, 483 F.2d 209, 213 (9th Cir. 1973) (noting that a taxpayer’s failure to realize the substance or amount of a contingent liability assumed when acquiring property does not change its tax treatment—the payment must be capitalized); but see Nahey v. Commissioner, 196 F.3d 866, 870 (7th Cir. 1999) (criticizing Pacific Transport in dicta). In this case, protection from an aberrant jury verdict needed to be sought during contract formation, not after the fact in the form of an immediate tax deduction. Moreover, ITW’s entire premise that its actions after assuming the liability should be examined for the effect it had on increasing the amount of the ultimate indebtedness strays from the inescapable fact that, like the taxpayer in Webb, it accepted the indebtedness in order to acquire what it perceived to be a future benefit—DeVilbiss. Part of ITW’s process of valuing the DeVilbiss assets and arriving at the purchase price included evaluating the Lemelson lawsuit. In that due diligence phase, ITW assessed a value to the suit based on how it foresaw the litigation unfolding once it took control of the defense. Its ability to affect the outcome of the Lemelson lawsuit was therefore already factored in. That things did not go according to plan, and that, in retrospect, it should have paid far less for DeVilbiss to account for size of the judgment assigned, does not change the tax character of the judgment in this case.