Petition — St. Petersburg Bank & Trust Co. v. United States

JUN 3 1975

IN THE MICHAL! te ne

Supreme Court of the United States

October Term, 1974

no. 74-1519

ST. PETERSBURG BANK AND TRUST COMPANY

Petitioner

v.

UNITED STATES OF AMERICA

Respondent

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

MICHEL G. EMMANUEL

and

JOSEPH D. EDWARDS

of

CARLTON, FIELDS, WARD,

EMMANUEL, SMITH & CUTLER, P.A.

P. O. Box 3239

Tampa, Florida 33601

Counsel for Petitioner

FREE PRESS PUBS. CO., INC., TAMPA, FLORIDA

i

INDEX

Page

Reference to Opinions Below Sisk talbbaabinddietaaiianiate 1

Grounds on Which Jurisdiction is Invoked ______ 1

The Questions Presented for Review ____________ 2

RY I pc cicceares voueeketucacowen. 2

Statement of the Case _.._._......._________.. 3

Reasons for Allowance of the Writ ____________ 5

I sea cecinain tit eae ate eRe 9

Appendix A - Order of the Court of Appeals ____ A-1

Appendix B - Opinion of the District Court ______ B-1

IN THE

Supreme Court of the United States

October Term, 1974

NO.

ST. PETERSBURG BANK AND TRUST COMPANY

Petitioner

v.

UNITED STATES OF AMERICA

Respondent

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT |

REFERENCE TO OPINIONS BELOW

The opinion of the District Court for the Middle

District of Florida (Appendix B) is reported at 362

F.Supp. 674. The per curiam opinion of the Court of

Appeals for the Fifth Circuit (Appendix A) affirming

the opinion of the District Court is not reported.

GROUNDS ON WHICH JURISDICTION IS INVOKED

The opinion of the Court of Appeals affirming the

District Court’s decision was entered on October 30,

1974. Petitioner’s motion for rehearing was denied by

the Court of Appeals on March 7, 1975. Jurisdiction to

review the judgment of the Court of Appeals is con-

ferred on this Court by 28 U.S.C. Section 1254(1).

2

THE QUESTIONS PRESENTED FOR REVIEW

1. Where a bank undertakes an extensive program

of entertaining community leaders and businessmen in

a concerted effort to increase its business, are the costs

incurred in that effort deductible for Federal income

tax purposes:

2. Where there are substantial numbers of bank

officers, directors and employees in attendance at

functions sponsored by the bank each of whom is in-

structed to discuss and solicit bank business and de-

velop goodwill with the guests, is the entertainment

directly related to the active conduct of a trade or busi-

ness within the meaning of section 274 of the Internal

Revenue Code of 1954, as amended: and

3. Where discussions held during the entertain-

ment actually serve to increase the bank’s ~usiness and

develop goodwill must other, different business discus-

sions be held before or after the entertainment before

the costs will be deductible as being “associated with”

the active conduct of a trade or business.

STATUTE INVOLVED

The only statute involved is Section 274(a) of the

Internal Revenue Code of 1954, as amended, (26 U.S.C.

§274) which reads, in part, as follows:

Sec. 274. DISALLOWANCE OF CERTAIN

ENTERTAINMENT, ETC. EXPENSES

(a) Entertainment, Amusement, or Recreation.-

3

(1) In General.- No deduction otherwise allow-

able under this chapter shall be allowed for any

item.

(A) Activity.- With respect to an activity

which is of a type generally considered to con-

stitute entertainment, amusement, or recreation,

unless the taxpayer establishes that the item

was directly related to, or, in the case of an item

directly preceding or following a substantial and

bona fide business discussion (including business

meetings at a convention or otherwise), that such

item was associated with, the active conduct of

the taxpayer’s trade or business, or

and such deduction shall in no event exceed the

portion of such item directly related to, or, in

the case of an item described in subparagraph

(a) directly preceding or following a substantial

and bona fide business discussion (including

business meetings as a convention or otherwise),

the portion of such item associated with the ac-

tive conduct of the taxpayer’s trade or business.

STATEMENT OF THE CASE

The case has developed purely as an issue of law.

The facts have never been in dispute; the only question

is the proper construction of the foregoing provisions

of Section 274 of the Internal Revenue Code of 1954,

as amended.

Petitioner is a relatively new but progressive and

fast-growing bank. It undertook an extensive program

of entertaining business leaders, wealthy individuals,

public officials and other people in positions to control

4

deposits and to otherwise beneficially affect the bank’s

business.

Several times each year the bank sponsored formal

parties and less formal dove shoots followed by cocktail

parties or barbecues. The functions were hosted by the

bank’s president and chairman of its board of directors.

Invitations were issued on bank stationery or with

RSVP to the bank’s telephone. The invitations were

highly prized and the functions were well attended.

Present at the events there were always numerous

bank officers, stockholders, directors and employees

who endeavored to solicit business for ihe beak from

the guests. Most of the officers and other employees

of the bank were not social acquaintances of the bank’s

president and their only reason for attendance was to

promote the bank. The entertainment actually enhanced

the goodwill of the bank, contributed to its substantial

growth, and constituted a shrewd and fully justifiable

expenditure in pursuit of economic success. The expen-

ditures constituted an ordinary and necessery expense

of Petitioner’s business.

The Internal Revenue Service argued and the Dis-

trict Court held, however, that such business motivated

expenditures are not deductible because of the pro-

visions of Section 274(a) of the Internal Revenue Code

of 1954, as amended. The lower courts found the enter-

tainment not to be “directly related” to the active con-

duct of a bank’s trade or business. Furthermore, while

the entertainment was “associated with” the active

conduct of the business, it did not directly precede or

follow a bona fide business discussion: the entertain-

5

ment was contemporaneous with the discussions. Con-

sequently deductions were denied for the costs of the

parties and dove shoots.

The basis for federal jurisdiction in the District

Court was a suit pursuant to 28 U.S.C. 1346(a) (1) for

the recovery of income taxes paid by Petitioner as a

result of a deficiency assessment made by the Commis-

sioner of Internal Revenue for the tax years 1965 and

1966.

REASONS FOR ALLOWANCE OF THE WRIT

It is important that the decision of the Court of

Appeals below be reviewed by this Court and reversed,

for the following reasons:

1. Matter of First Impression. The issue in this

case has never been decided. The District Court deplored

the lack of judicial authority with respect to a statute

enacted in 1962. THE WALL STREET JOURNAL _ con-

sidered the decision below important enough to be head-

lined on its front page. The lack of judicial guidelines

in this bread and butter area of everyday concern cries

out for this Court’s attention — the precedent estab-

lished by this case will affect significant business

practices throughout the country.

2. Broad Implications. Based strictly on the con-

struction of the statute, this case has implications far

beyond its particular fact situation. The lower courts’

decisions mean that no taxpayer may claim a deduction

for entertaining customers at functions such as an open

house announcing a new office; no deduction may be

claimed for such traditional expenses as entertaining

customers at Christmas time; no trust company may

—

6

deduct the costs of entertaining estate practitioners;

no artist can deduct the costs of a party announcing

a new show; nor an architect the cost of celebrating

the opening of a new project. Any business aggressively

seeking profits by virtue of its friendly, personal ser-

vice, such as this bank did, will be at a competitive dis-

advantage because it cannot deduct the costs of its

efforts .

Unbelievably, the lower courts have disallowed de-

ductions for entertainment of that nature regardless

of the business results derived from the blatantly com-

mercial entertainment. While each of these functions

may have a definite and demonstrable effect on the tax-

payer’s business — as the District Court found it did

in the instant case — the District Court’s opinion, af-

firmed by the Court of Appeals, held as a matter of law.

that Section 274(a) denies any deduction for this type

of expenditure.

3. Tax Jungle. The District Court seems to have

concluded that Section 274, like the giraffe, is an un-

likely animal put together by a committee. It wrestled

with the statute, its attendant committee reports and

the Commissioner’s regulations, but got lost in the

jungle. It lost sight of the realities of the situations the

statute was designed to affect and the practicalities of

the business world.

4. Disasterous Results. The lower courts have ig-

nored the legislative history surrounding the enactment

of the statute. Disregarding Congress’ express desire

not to curtail expenditures for business entertainment

because of the effect such action would have on com-

7

mercial businesses and the entertainment industry, the

courts below have imposed severe and unwarranted

limitations on deductions for those expenses.

In a time of recession when Congress and industry

are doing all in their power to promote business, the

Fifth Circuit Court of Appeals has seen fit to raise new

road blocks to business expansion. Expenses for large

scale business promotions may not be deducted. The

costs of entertainment are deductible only if incurred

in the intimacy of small groups.

By definition, the courts say, entertainment for the

purpose of stimulating business is not directly related

to the active conduct of a business. This, say the courts,

is true regardless of the economic success derived from

the entertainment and without the necessity of exam-

ining the circumstances or surroundings of the parties.

if the result is the production of goodwill rather than

a signed contract, the lower courts hold the entertain-

ment cannot be directly related to the conduct of a busi-

ness.

The entertainment may be associated with a trade

or business, but is deductible only if it immediately pre-

cedes or follows serious business negotiations. A nego-

tiating session must be held with each guest within hours

of the entertainment. Of necessity, the number of people

who can be entertained under such circumstances is

quite small.

Large Christmas parties, open houses at which

specific negotiations are not held, receptions and other

similar business practices no longer result in tax de-

ductible expenditures.

8

5. Shocking. The business expenses so blithely

found not to be deductible by the lower courts are com-

monly incurred in business. That they are not deduc-

tible comes as quite a surprise to the business commun-

ity and the shock is compounded with the knowledge

that the decision was made as a matter of law, com-

pletely divorced from an analysis of the facts. Indeed,

the facts in this case, as determined by the District

Court, are that the entertainment was business moti-

vated, shrewdly designed to promote business and ef-

fective in increasing the bank’s revenues.

6. Wide Ramifications. The money expended by

this taxpayer is but a miniscule part of the amount

spent by all businesses in similar endeavors. Should the

lower courts’ opinions be uniformly applied to all tax-

payers, it would cut to a trickle the millions of dollars

now spent by businesses in developing goodwill. The

damage to the commercial and entertainment industries

sought to be avoided by Congress is sure to result.

This court must act to prevent the further damage

to the economy foretold by the lower courts’ opinions.

CONCLUSION

For all the reasons set forth above, Petitioner’s

petition should be granted and the requested writ of

certiorari issued.

Respectfully submitt4d,

e

e

MICHEL

and

JOSEPH D. EDWARDS

of

CARLTON, FIELDS, WARD,

EMMANUEL, SMITH & CUTLER, P.A.

P. O. Box 3239

Tampa, Florida 33601

Counsel for Petitioner

A-1

APPENDIX A

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

NO. 73-3762

ST. PETERSBURG BANK & TRUST COMPANY,

Plaintiff-Appellant,

vs:

UNITED STATES OF AMERICA,

Defendant-Appeilee.

Appeal from the United States District Court for the

Middle District of Florida.

(October 30, 1974)

Before WISDOM and BELL, Circuit Judges, and

BREWSTER, District Judge.

PER CURIAM:

AFFIRMED. See Local Rule 21.' We adopt the

opinion of the district court as the opinion of this Court.

See N.L.R.B. v. Amalgamated Clothing Workers of

America, 5 Cir. 1970, 430 F.2d 966.

B-1

APPENDIX B

674

cata. Chicot County Dist. v. Bank, 308

U.S. 371, 60 S.Ct. 317, 84 L.Ed. 329

{1940]. In that opinion, the Court held

that the aggrieved party had the oppor-

tunity to raise the constitutional ques-

tion on appeal of the first decision and

that collateral attack should be barred

by the doctrine. This Court will make a

similar finding. Michael Baldwin could

have objected to the constitutionality of

the award of attorney's fecs cither to

the divorce court or in an appeal to the

State Supreme Court of the decree of di-

voree. He is barred from raising the

question by the doctrine of res judicata

in the dischargeability of debt proceed-

ings by the Referee. The order of the

Referee denying discharge will therefore

be affirmed and the petition for review

will be dismissed.!

ef) MUPRL ER Brolin

ST. PETERSSURG BANK & TRUST

COMPANY, Plaintiff,

Vo

UNITED STATES of America,

Defendant.

Civ. No, 71-425.

United States District Court

M. D. Florida.

Tampa Division.

Aug. 27, 1973.

Action to recover income taxes paid.

The District Court, Hodges, J., held that

expenses incurred in connection with

dinner parties and dove shoots conducted

at home and ranch of controlling share-

holder, president and chairman of board

of directors of bank were not deductible

in computing bank's income tax.

Order accordingly.

‘hischarge of

Referee Michael

review of this Court

i Cther grounds for

were sSulmitted to the

aidwin has sought the

362 TEDERAL SUPPLEMENT

1. Internal Revenne Co555

Statute relating to disallowance of

certain entertainment expenses created

general class of entertainment expenses

which must be directly related to active

conduct of taxpayers trade or business

and second class which must be associat-

ed with taxpayer's business and be in-

curred directly preceding or following

substantial and bona fide business dis-

26 U.S.C.A, (1.R.C.1954) § 274.

cussion,

---

2. Internal Revenue Ces55

Expenses incurred for dinner par-

ties and dove shoots held at home and

ranch of controiling stockholder, presi-

dent and chairman of board of directors

of bank were not “directly related” to

business of bank and were not deducti-

ble in computing bank's income tax even

though they contributed to bank's suc-

cess. 26 U.S.C.A. (1.R.C.1954) §§ 162,

274.

See publication Words and J'hrases

for other judicial constructions and

definitions,

3. Internal Revenue Co-555

Income tax deduction for expenses

incurred in conducting affairs which

would normally be regarded as essential-

ly social or entertaining in nature is

permitted only if they are directly relat-

ed to taxpayer's business or are in con-

junction with meetings or conferences

during which substantial and bona fide

business matters are discussed.

4. Internal Revenue C555

Expenses incurred in connection

with dinner parties and dove shoots con-

ducted at home and ranch of controlling

shareholder, president and chairman of

board of directors of bank were not “as-

sociated with” meetings or conferences

during which substantial and bona fide

business matters were discussed and

were not deductible in computing bank's

income tax even though parties contrib-

uted to bank’s success and on some occa-

sions there was discussion of specific

bank affairs between bank employees

ity oes to the ruling on the constitutional

ee -

| DEST COPY. AYALABL

B-2

ST. PETERSBURG BANK & TRUST COMPANY v. UNITED STATES 675

Cite as 362 F.Supp. 674 (1074)

and persons attending affairs. 26 U.S.

cA. (1.R.C.1954) §§ 162, 274.

See publication Words and Phrases

for other judicial constructions and

definitions,

_ sO

Michel G. Emmanuel, Michael D. An-

nis, of Carlton, Fields, Ward, Emman-

uel, Smith & Cutler, Tampa, Fla., for

plaintiff.

Scott P. Crampton, Asst. Atty. Gen.,

Jerome Fink, Daniel C. Perri, Attys.,

Dept. of Justice, Washington, D. C., for

defendant.

OPINION

HODGES, District Judge.

St. Petersburg Bank & Trust Compa-

ny (the Bank) instituted this suit pur-

suant to 28 U.S.C.A. § 1346(a)(1) for

the recovery of income taxes paid by it

as a result of a deficiency assessment

made by the Commissioner of Internal

Revenue for the tax years 1965 and

1966. The issue is the propriety of cer-

tain deductions made by the Bank for

entertainment expenses during those

years. The governing provisions of the

Code are Sections 162 and 274, Internal

Revenue Code of 1954, as amended (26

U.S.C.A. §§ 162 and 274).

The Bank was organized in 1955 by

Mr. Hubert Rutland and others. Mr.

Rutland, a well-known St. Petersburg

businessman, is the controlling share-

holder, president and chairman of the

board of directors. From its inception

the Bank has aggressively and success-

fully sought out business from large de-

positors, borrowers and _ settlors of

trusts. Taking the view that compcti-

tion in the banking industry is largely

confined to the area of personal services

and relationships, the Bank has consist-

ently endeavored to project the image of

a local institution offering friendly, cffi-

cient and personal services to local busi-

nessmen, governmental entities and resi-

dents. Its implementation of that con-

cept has principally focused upon and

emphasized the management position of

Hubert Rutland, and virtually ali of tne

Bank's public advertising has sought to

exploit both his professinal and social

reputation in the community.

The expenses in dispute were incurred

as a result of certain cocktail and dinner

parties held at the Rutland home in St.

Petersbury, and certain dove shoots and

barbecues held at the Rutland ranch in

Manatce County, approximately 30 miles

to the South and East of St. Petersbury.

In 1965 there were two such parties or

receptions in the Rutland home, and

three dove shoots at the Rutland ranch.

In 1966 there was one reception in the

home, a second party at another location

and four dove shoots at the ranch. At-

tendance at these functions was by invi-

tation only, and the written invitations

were issued in the names of Mr. and

Mrs. Rutland. The number of guests

varied from approximately 50 persons to

as many as 250, and there was no out-

ward indication to those in attendance

that any of the affairs were sponsored

by the Bank. The costs, however, were

paid by the Bank with the apparent ap-

probation of its board of directors. The

guest lists were compiled so as to in-

clude customers or potential customers

of the Bank, business leaders, public of-

ficials, persons of substantial wealth and

others in a position to control large de-

posits or otherwise direct bencficial

business to the Bank. In addition, a

number of the Bank’s officers and key

employees were invited on each occasion.

Most of these persons clearly understood

that they were asked to attend only be-

cause they were Bank employees, and

many were specifically instructed to cir-

culate among the guests, pass out their

business cards, and gencrally tout the

services of the Bank while nurturing a

personal rapport with established or po-

tential customers. On several occasions

the employees took advantage of the op-

portunity to discuss specific transac-

tions, either pending or contemplated.

The evidence generally supports the

conclusion that these parties enhanced

the good will of the Bank, contributed to

its substantial growth, and constituted a

676 362 FEDERAL SUPPLEMENT

shrewd and fully justifiable expenditure

by the Bank or its board of directors in

pursuit of cconomic success. As a result

—and the Government at least tacitly

conceded the point—such expenses would

appear to be deductible as “ordinary and

necessary” business expenses within the

purview of Section 162 of the Code (26

U.S.C.A. § 162) as interpreted and ap-

plied through 1962. See First National

Bank of Omaha vy. United States, 276

F.Supp. 905 (D.Neb.1967). The ulti-

mate issue in the case, therefore, is the

proper construction to be made of Sec-

tion 274 (26 U.S.C.A. § 274), and a de-

termination as to whether the subject

expenses mect the admittedly more

stringent requirements of that provi-

sion,

Section 274 was added to the Code in

1962,' and its genesis is best described

in the Senate Committee Report: ?

“The Treasury brought to the atten-

tion of Congress that widespread

abuses have developed through the use

of the expense account. In his tax

message to the Congress last year, the

President stated his conviction that

entertainment and related expenses,

even though having a connection with

the needs of business, confer substan-

tial tax-free personal benefits on the

recipients, and that in many instances

deductions are obtained by disguising

personal expenses as business expens-

es. He recommended that the cost of

such business entertainment and the

maintenance of entertainment facili-

ties be disallowed in full as a tax de-

duction and that restrictions be im-

posed on the deductibility of business

gifts and travel expenses.

“Much of the abuse described by

the President can be traced to the

broad judicial and administrative i

terpretation given to the term ‘ordi-

nary and necessary’ which has result-

ed in many entertainment expenses

being allowead as deductions where

. Revenue Act of 1962, Public Law 87-834,

$4; 76 Stat. 960.

their connection with a trade or busi-

ness is quite remote. Under present

laws, where a business purpose, how-

ever slight, exists, then the entertain-

ment expenses generally are fully de-

ductible if they are ‘ordinary and nec-

essary’ business expenses.

“After careful consideration of the

proposal, your committee has conclud-

ed that deductions for entertainment

and traveling expenses and business

gifts should be restricted to prevent

abuses.”

Congress thus resolved to make the

law more restrictive in the area of busi-

ness entertainment deductions, not by

amendment. of Section 162 governing

business expenses in general, but by the

passage of a new and separate provision

dealing solely with items of entertain-

ment. As it ultimately evolved and be-

came enacted, Section 274(a)(1)(A)

provides as follows:

Ҥ 274. Disallowance of certain en-

tertainment, etc. expenses

(a) Entertainment, amuscment, or

recreation.—

(1) In general.—No _ deduction

otherwise allowable under this

chapter shall be allowed for any

item—

(A) Activity —With respect to

an activity which is of a type

generally considered to constitute

entertainment, amusement, or rec-

reation, unless the taxpayer es-

tablishes that the item was di-

rectly related to, or, in the case of

an item directly preceding or fol-

lowing a substantial and bona

fide business discussion (includ-

ing business meetings at a con-

vention or otherwise), that such

item was associated with, the ac-

tive conduct of the taxpsyer’s

trade or business, 7

{1) Careful reading of this provision

discloses a rather curious dichotomy of

2. S.Rep. No. 1881, A7th Cony., 2nd Sexe.

(1962) ; U.S.Code, Congressional and Ad-

ininistrative News, pp. 3304, 3327 (1962).

B-4

ST. PETERSBURG BANK & TRUST COMPANY v. UNITED STATES 677

Cite as (2 PF Supp. aTe Oat

standards —“directly related” and “asso-

ciated with.” The statute clearly cre-

ates two classes of entertainment expens-

es which are measured by separate

tests in determining deductibility. One

class is general, the other is specific.

Entertainment expense in general must

be “directly related” to “the active con-

duct of the taxpayer's trade or busi-

ness.” On the other hand, in the case of

an expense incurred for entertainment

“directly preceding or following a sub-

stantial and bona fide business discus-

sion,” it need only be “associated with”

the taxpayer's business in order to qual-

ify for deduction.

The Bank contends, first, that on the

peculiar facts of this case the expenses

involved easily qualify under the “di-

rectly related” test and the Treasury

tegulations expanding upon that stand-

ard. Secondly, and alternatively, it con-

tends that even if the disputed expenses

were not “directly related” to its busi-

ness, they surely qualify under the less

exacting “associated with” test. Inher-

ent in the latter assertion is the added

contention that the qualifying language

—‘‘preceding or following a substantial

and bona fide business discussion’-

does not mean that the business discus-

sions and the entertainment cannot be in

process simultaneously. To evaluate and

resolve these issues it is necessary to ex-

amine the legislative history of the stat-

ute in depth and, to a lesser degree, the

Treasury Regulations promulgated since

its enactment.

I LEGISLATIVE HISTORY

As already noted, the purpose of Con-

gress was to tighten the existing law

and prevent abuses that had developed

under Section 162. The President's rec-

3. This case is a clear example of the

phenomenon that so frequently occurs in

the study and practice of law, namely

the surprising paucity of decisional

authority dealing with a seemingly basie

or fundamental question. Although the

stntute is now over 10 years old, only one

recent decision has approached the issue

At wand, aud oC is Cw ucly distinguishable.

ommendation was hard and tough (see

Senate Report, supra), and the House

acted accordingly. Its bill would have

prevented any deduction for the cost of

business entertainment or the mainte-

nance of entertainment facilities in the

absence of a clear showing that such ex-

pense was “directly related” to the “ac-

tive conduct” of business. (H.Rep.No.

1447, 87th Cong. 2d Sess., 1962-3 Cum.

Bull. 405, 423-430). The Senate was

more reticent. It described its concern

and its attenuating amendments of the

House bill as follows: *

“The committee agrees that this

abuse of the tax law should not be

condoned, but on the other hand it

does not believe that complete disal-

lowance as recommended by the Presi-

dent is the proper solution to the

problem. Rather, your committee is

convinced that expenses incurred for

valid business purposes should not be

discouraged since such expenses serve

to increase business income, which in

turn produces additional tax revenues

for the Treasury.”

* * * o * *

“The House bill provides rules

which in general would: (1) disallow

a deduction with respect to entertain-

ment activities, except to the extent

that the expense is directly related to

the active conduct of a trade or busi-

ness; (2) disallow a deduction with

respect to entertainment facilities, un-

less the facility is used primarily for

the furtherance of the taxpayer's

trade or business and the expense is

directly related to the active conduct

of the trade or business; sf

. . * * . *

“Your committee's bill to a consid-

erable degree retains the basic struc-

See Hippodrome Oldsmobile, Ine. y.

United States, 474 F.2d 9590 (6th Cir.

1973).

4. S.Rep. No. ISS1, S7th Cong. 2d Sess,

(19652); ULS.Code, Congressional and Ad-

ministrative News, pp. 3304, 3327-23329

(1062).

678 362 FEDERAL SUPPLEMENT

ture of the House bill. However, the

effect of the principal provision (the

disallowing of a deduction for certain

entertainment expenses) has been

modified to permit the deduction of

expenses for goodwill where a close

association is estadlished between the

expense and the active conduct of a

trade or business.”

. : >

“To eliminate the harshness result-

ing from the House report, anend-

ment of the language of the llouse bill

is necessary. Despite amendment of

the House bill your committee has

made certain that entertainment ex-

pense abuses are climinated By

your committee's amendment an alter

native rule is added to the House bill

under which expenses for entertain-

ment, amusement, or recreation (with

respect to both activities and facili-

ties) also will be deductible to the ex-

tent that such expenses are associated

with the active conduct of a trade or

business. This new language wil! per-

mit deduction of expenses for enter-

lainment, amusement, vr recreation

incurred for the creation or mainte-

nance of business goodwill without re-

gard to whether a particular exception

applies. However, this new language

will apply only if the taxpayer demon-

strates a clear business purpose and

shows a reasonable expectation of de-

riving some income or other benefit to

his business as a result of the expend-

iture. If he meets this test, the ex-

penditure will be considered to be asso-

ciated with the active conduct of his

trade or business; otherwise, the

expense will be disallowed under your

committee's amendment.”

In essence, the Senate disapproved the

harshness of the House bill to the extent

that no deduction would be aliowed for

general goodwill entertainment. and it

opted for the middle ground between

Section 162 and the House version of

Section 274 so as to permit deduction of

5. IL.Conf.Rep. Ne. 2508, STth Cong. va

Sess, (12); US Code, Congressional

such expenses so long as they were “as-

sociated with” the business and the tax-

payer could show “a reasonable expecta

tion of deriving some income” as a re-

sult of the expenditure. This was the

posture of the bill, thcvefore, as it pro-

ceeded to consideration by the conference

commitltec.

The report of the conference commit-

tee, and the languave of the statute as

ultimately enacted, make it albundantl,

clear that the view of the House pre-

vailed, with one narrow exception. Thi

report states: 4

“Senate amendments Nos, 29. 20

and 3) inserted the words ‘or associat

ed with’ after the words ‘directly

lated to’ each place they appeared i:

the new section 274(4)(1) as passed

by the llouse.

“Under the conference agreement

the House recedes on Senate amend.

ment No. 29 with en amendment pro-

viding that deductions otherwise al- |

lowable under chapter 1 of the code

shall not be allowed for any item with

respect to an entertainment type ac

tivity ‘unless the taxpayer establishes

that the item was directly related to,

or, in the case of an item directly pre-

ceding or following a substantial and

bona fide business discussion (includ-

ing business mectings at a convention

or otherwise), that such item was as-

sociated with,’ the active conduct of

the taxpayer's trade or business. Un-

der the conference agreement, the

Senate recedes on amendment No. 30,

and the House recedes on amendment

No. 31 with an amendment conform-

ing to the action on amendment No.

29.

“The rule of the House bill as de-

scribed in the report of the Committee

on Ways and Means is more strict

than the ‘or associated with’ rule of

the Senate amendment. The rule of

the House bill would not allow deduc-

tion of expenditures for entertainment

occurring under circumstances where

-

and Achninistrative News, pp. 3722, 8735

S73 CHI)

B-6

ST. PETERSBURG BANK & TRUST COMPANY v. UNITED STATES 679

Cite as 362 F Sapp. 674 (1973)

there is little or no possibility of con-

ducting business affairs or carrying

on negotiations or discussions relat-

ing thereto, such as where the group

of persons entertained is large or the

distractions substantial.

“It is the understanding of the con-

ferees, both on the part of the House

and the Senate, that the alternative

Senate ‘or associated with’ test as de-

scribed in the report of the Finance

Committee would apply to certain en-

tertaining primarily to encourage

goodwill where the evidence of busi-

ness connection is clear, whether or

not business is actually transacted or

discussed during the entertainment.

The conference agreement would per-

mit a deduction for the cost of an en-

tertainment item, even though the

item is not directly related to the ac-

tive conduct of the taxpayer's trade or

business, if the item is associated

with it, so long as the entertainment

activity directly precedes or follows a

substantial and bona fide business dis-

cussion. The conditions under which

an item is ‘associated with’ the active

conduct of a trade or business are

contained in the report of the Com-

mittee on Finance. The deductibility

of other items of entertainment ex-

pense, as well as items with respect to

facilities, would be governed by the

rule of the House bill.

“Section 274(a) as ayreed to by the

conferees will allow as a deduction the

cost of entertaining connected with

what are primarily business meetings.

For example, if the taxpayer conducts

substantial negotiations with a group

of business associates and that eve-

ning entertains the group and their

wives at a restaurant, theater, concert,

or sporting event, such entertainment

expenses, if assucfated with the active

conduct of the taxpayer's business,

will be deductible even though the

purpose of the entertainment is mere-

ly to promote goodwill in such busi-

ness. Moreover, if a group of busi-

ness associates with whom the taxpay-

er is conducting business mectings

comes from out of town to the taxpay-

er’s place of business to hold substan-

tial business discussions, the enter-

tainment of such business guests by

the taxpayer the evening prior to the

business discussions will be regarded

as directly preceding the business dis-

cussions.

“Similarly, if in between, or in the

evening after, business meetings at a

convention, the taxpayer entertains

his business associates or prospective

customers attending such mectings

(and their wives), such entertainment

will be considered as directly preced-

ing or following a business discus-

sion.” (Emphasis supplied)

In summary, and as the enacted stat-

ute shows, the Senate receded altogether

with respect to Section 274(a)(1)(B),

dealing with entertainment facilities,

and the “directly related” test is the sole

standard to be applied as to those items.

Hippodrome Oldsmobile, Inc. v. United

States, 474 F.2d 959 (6th Cir. 1973).

The Senate’s less stringent “associated

with” test was retained in Section

274(\a)(1)(A)—the provision at issue—

but only after a compromise amendment

which qualified and limited that test to

those expense items “directly preceding

or following a substantial and bona fide

business discussion (including business

meetings at a convention or otherwise).”

II THE DIRECTLY RELATED

TEST

The Treasury Regulations promulgat-

ed under Section 274 generally restate

the sense of Congress as revealed by the

committee reports. Thus, among other

criteria not pertinent to this case, Sec-

tion 1.274-2(c)(3)(i)-(iv) of the regu-

lations (26 C.F.R.) establishes four sep-

arate requirements, all of which must be

met for an entertainment item to quali-

fy as a “directly related” expense.

Subsection (i) set forth the first of

these requirements as follows:

“(i) At the time the taxpayer made

the entertainment expenditure (or

committed himself to make the ex-

680 362 FEDERAL SUPPLEMENT

penditure), the taxpayer had more

than a general expectation of deriving

some income or other specific trade or

business benefit (other than the good-

will of the person or persons enter-

tained) at some indefinite future time

from the making of the expenditure.

A taxpayer, however, sha!) not be re-

quired to show that income or other

business benefit actually resulted

from each and every expenditure for

which a deduction is claimed.” (Em-

phasis supplied)

In addition, Section 1.274-2/(c)(7) of

the same regulation (26 C.F.R.) pro-

vides:

“(7) Expenditures generally consid-

ered not directly related. Expendi-

tures for entertainment, even if con-

nected with the taxpayer's trade or

business, will generally be considered

not directly related to the active con-

duct of the taxpayer's trade or busi-

ness, if the entertainment occurred

under circumstances where there was

little or no possibility of engaging in

the active conduct of trade or busi-

ness, The following circumstances

will generally be considered circum-

stances where there was little or no

possibility of engaging in the active

conduct of a trade or business:

(i) The taxpayer was not present;

(ii) The distractions were substan-

tial, such as

(a) A meeting or discussion at

night clubs, theatres, and sporting

events, or during essentially social

gatherings such as cocktail parties,

" (Emphasis supplied)

{2} Thus, insofar as the “directly re-

lated” test is concerned, it scems mani-

fest that the entertainment involved in

this case fails to qualify. There can be

no doubt that the parties hosted by the

Rutlands were motivated primarily by

business considerations and that the

Bank was the ultimate beneficiary of

their social efforts. Yet it is equally

clear that the benefit enjoyed by the

Bank was of the goodwill variety de-

rived from a purely social setting and,

as such, was precisely the type of ex-

pense deduction that Congress intended

to climinate by way of the “directly re-

lated” test.

III THE ASSOCIATED WITH

TEST

The above conclusions do not neces-

sarily disqualify the expenses, however,

under the “associated with” test. That

test, as intended hy the Senate, is suffi-

ciently relaxed to accommodate and al-

low deduction of certain goodwill items.

The regulations say (26 C.F.R. § 1.274 -

2(d:(2)):

“(2) Associated entertainment de-

fined. Generally, any expenditure for

entertainment, if it is otherwise allow-

able under chapter 1 of the Code, shall

be considered associated with the ac-

tive conduct of the taxpayer's trade or

business if the taxpayer establishes

that he had a clear business purpose

in making the expenditure, such as to

obtain new business or to encourage

the continuation of an existing busi-

ness relationship.”

The “associated with” test is limited,

nevertheless, by the express qualifica-

tion, imposed in conference, that the ex-

pense must relate to an item “directly

preceding or following a substantial and

bona fide business discussion (including

business meetings at a convention or

otherwise).” Again echoing the views

reflected in the conference committee re-

port, supra, the regulations provide (26

C.F.R. § 1.274-2(d)(3)(ii)):

“(ii) Directly preceeding or follow-

ing. Entertainment which occurs on

the same day as a substantial and

bona fide business discussion (as de-

fined in subdivision (i) of this sub-

pararraph) will be considered to di-

rectly precede or follow such discus-

sion. If the entertainment and the

business discussion do not occur on

the same day, the facts and circum-

stances of cach case are to be consid-

ered, including the place, date and du-

ration of the business discussion,

whether the taxpayer or his business

_—

ST. PETERSBURG BANK & TRUST COMPANY v. UNITED STATES 681

Cite ax 382 F Sapp. O71 C1974)

associates are from out of town, and,

if so, the date of arrival and depar-

ture, and the reasons the entertain-

ment did not take piace on the day of

the business discussion. For example,

if a group of business associates

comes from out of town to the taxpay-

er’s place of business to hold a sub-

stantial business discussion, the enter-

tainment of such business guests and

their wives on the evening prior to, or

on the evening of the day following,

the business discussion would general-

ly be regarded as directly preceding or

following such discussion.”

{3] Since the “associated with” test

is, in effect, an exception and not a gen-

eral rule, the applicability of the test to

specific facts is best determined when it

is examined in juxtaposition with the

“directly related” test as the basic

standard. Concerning cocktail or dinner

parties and other affairs such as those

involved in this case, all of which would

normally be regarded as essentially so-

cial or entertaining in nature, deduction

of the expense is generally permitted

only if the stringent requirements of the

“directly related” standard are met.

The mere purpose of fostering good will

is insufficient to show a direct relation-

ship to the business. On the other hand,

when such affairs are sponsored in con-

junction with meetings or conferences

during which substantial and bona fide

business matters are discussed, the cost

of entertaining the participants as a

good will expense item will be deductible

as “associated with” the business.

Practical application of the test is best

typified by the illustrative examples giv-

en in the Conference Report and the

Regulations, i. e., the familiar situations

in which business conferences are con-

ducted by day and out of town partici-

pants are entertained by night.

[4] Viewed in this way, the conclu-

sion is inescapable that the Bank's dis-

puted entertainment expenses also fail to

362 F Supp. —4344

satisfy the requirements of the “asso-

ciated with” test. It is not even sug-

gested by the Bank that the social gath-

crings were in any sense an adjunct of

formal business meetings. Rather, the

Bank insists that the “associated with”

test should not he narrowly confined to

those precise situations in which the en-

tertainment literally “precedes” or “fol-

lows” substantial business discussions,

and that expenses may still qualify for

deduction under that less demanding

test even though the business discus-

sions are conducted during the course of

a combined social/business function.

And, to be sure, there is at least one

passage in the Conference Report (quot-

ed supra) which lends support to this

contention.

On the facts of this case, however,

that construction and application would

tolerate if not invite a head-on collision

between the two tests, and would result

in a statutory paradox. If the “asso

ciated with” test was intended to apply

to cocktail and dinner parties, or dove

shoots and barbecues mercly because

some business is discussed and good will

is promoted, to what type of cntertain-

ment expense would the more demanding

“directly related” test ever be applica-

ble? Further exploration of that ques-

tion here would require an indulgence in

conjecture concerning potential factual

situations not yet presented and unnec-

essary to decide. The future may well

yield a case in which the “associated

with” standard might be applied in the

manner suggested by the Bank. Suffice

it to say, however, that to bring the

present expenses .ithin the scope of

that test would necessitate an unwar-

ranted expansion of its limited area at

the expense of the primary “directly re-

lated” test and the field it occupies.

The Clerk is directed to enter judg-

ment in favor of the Defendant, dismiss-

ing the complaint with costs to be as-

sessed according to law.