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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1975
- **Citation:** 423 U.S. 834

## Text

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.

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385003_0496%3A1. Public record. Not legal advice.