Court Opinion

ID: 4482047
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:16.603129+00
Date Added: 2024-06-11T15:03:38.313631
License: Public Domain

Featherston, J., dissenting: In my opinion, the tracing concept here adopted by the majority is inconsistent with the language of section 482 and its implementing, regulations. Section 482 authorizes the Secretary to “distribute, apportion, or allocate gross income, deductions, credits, or allowances” between related organizations “if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations.” Nothing in this language limits the authorization to situations in which the non-arm’s-length transaction produces taxable income in the tax year. Section 1.482-1 (b), Income Tax Kegs., declares that the purpose of section 482 is to permit the determination of the “true taxable income” of a controlled taxpayer. Section 1.482-1 (a) (6), Income Tax Kegs., defines “true taxable income” as follows: (6) The term “true taxable income” mean®, in the ease of a controlled taxpayer, the taxable income (or, as the ease may he, any item or element affecting taxable income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular contract, transaction, arrangement, or other act) dealt with the other member or members of the group at arm’s length. It does not mean the income, the deduction's, the credits, the allowances, or the item or element of income, deductions, credits, or allowances, resulting to the controlled taxpayer by reason, of the particular contract, transaction, or arrangement, the controlled, taxpayer, or the interests controlling it, chose to make (even though such contract, transaction, or arrangement be legally binding upon the parties thereto). Section 1.482-2(a) of the regulations deals specifically with “loans or advances” as a factor in the determination of true taxable income. It provides that where one member of a group of controlled entities makes a loan or advance to another— and charges no interest, or charges interest at a rate which is not equal to an arm’s length rate * * * the district director may make appropriate allocations to reflect an arm’s length interest rate for the use of such loan or advance. ¡Section 1.482-1 (d) (4) of the regulations, dealing with methods for reallocating gross income and deductions, further provides in part: if one member of a group lends money to a second member of the group in a taxable year, the district director may make an appropriate allocation to reflect an arm’s length charge for interest during such taxable year even if the second member does not realize income during such year. The provisions of this sub-paragraph apply even if the gross income contemplated from a series of transactions is never, in fact, realized iby the other members. As I read section 482 and these regulations, the applicability of that section does not depend upon the realization of pretax profits from a particular non-arm’s-length transaction or, in the case of borrowed funds, the use to which they are placed. The section refers to “gross income” and “deductions” and does not specify the source from which they may be derived. To justify an interest allocation where the borrowing organization is producing gross income, it is necessary only that the waiver of interest would not have been made “had the taxpayer in the conduct of * * * [its] affairs been an uncontrolled taxpayer dealing at arm’s length with another uncontrolled taxpayer.” Sec. 1.482-1 (c), Income Tax Regs. I fail to see how the tracing concept, which involves an analysis of the borrowing corporation’s use of the advanced funds and the financial results of such use during the tax years, can be squared with these regulations. Moreover, I think the concept gives birth to a mischievous rule. Apart from the endless disputes it will engender as to whether particular uses of the borrowed funds (e.g., to pay overhead, capital expense, long-term investments, etc.) produced income during the tax years, it places a premium on accounting sophistication and lays a “trap for the unwary.” By the simple expedient of investing the particular borrowed dollars in nonproductive assets, section 482 can be circumvented even though such investment releases other funds for income-producing uses. On the other hand, if the borrower is not aware of this limitation which the majority is writing into the regulations and mingles the borrowed dollars with other capital, section 482 may be applied. In most situations, commonly controlled corporations are subject to the same tax rates, and there is no compelling reason to apply section 482. However, there are situations in which section 482 can be a useful tool to prevent tax “evasion” and to clearly reflect income (e.g., where one member of the controlled group is subject to the accumulated-earnings tax, where one is a foreign corporation, where one is a personal holding company, where one has operating losses and the other gains,1 Where a precise computation of earnings and profits of one of the corporations is important, etc.). Rather than lay down a rule which places such a premium on skillful bookkeeping, I would prefer to see the regulations declared invalid in the expectation that Congress would then focus on the problem. However, I think the regulations are consistent with the section. They have been sustained in B. Forman Co. v. Commissioner, 453 F. 2d 1144 (C.A. 2, 1972). After reviewing several cases—most of them decided before the 1968 regulations were issued—the court said (at p. 1156) : To the extent that the above cases cited by taxpayers may be read as holding that no interest can be allocated under § 482 under the facts of this case, they are not in accord with either economic reality, or with the declared purpose of section 482. They seriously impair the usefulness of § 482. Those cases may be correct from a pure accounting standpoint. Nevertheless, interest income may be added to taxpayers’ incomes, as long as a correlative adjustment is made * * *, for then the true taxable income of all involved will be properly reflected. * * * I do not think the majority satisfactorily distinguishes the principles underlying the Forman decision, and I think we should follow it. I respectfully dissent from the majority’s holding that interest reallo-cations may not be imputed with respect to the funds invested in non-income-producing stock.  Loss corporations present prime opportunities for the shifting of profits among members of the group, and the Commissioner is unquestionably authorized by sec. 482 to correct distortion of their income. See, e.g., Likins-Foster Honolulu Corp. v. Commissioner, 417 F.2d 285, 292 (C.A. 10, 1969), certiorari denied 397 U.S. 397 (1970); Baldwin-Lima-Hamilton Corp. v. United States, 435 F.2d 182, 185 (C.A. 7, 1970).