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

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JUN O°

IN THE

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Supreme Court of the United States

October Term, 1974

NO. 74-1519

ST. PETERSBURG BANK AND TR!*T COMPANY

Petitioner

v.

UNITED STATES OF AMERICA

Respondent

SUPPLEMENTAL APPENDIX TO

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

i

INDEX

Letter denying motion for rehearing en-banc ............. A-1

Opinion of District Court for the Middle District of Florida . A-2

A-1

UNITED STATES COURT OF APPEALS

Fifth Circuit

Office of the Clerk

March 7, 1975

TO ALL COUNSEL OF RECORD

Re: 73-3762 ST. PETERSBURG BANK & TRUST COMPANY

V. U.S.A.

Dear Counsel:

This is to advise that an order has this day been entered denying

the petition( ) for rehearing, and no member of the panel nor

Judge in regular active service on the Court having requested

that the Court be polled on rehearing en banc (Rule 35, Federal

Rules of Appellate Procedure; Local Fifth Circuit Rule 12) the

petition( ) for rehearing en banc has also been denied.

See Rule 41, Federal Rules of Appellate Procedure for issuance

and stay of the mandate.

Very truly yours,

EDWARD W. WADSWORTH

CLERK

Signed Anne G. Parent

By Anne G. Parent

Deputy Clerk

cc: Messrs. Michael G. Emmanuel

Michael D. Annis

Joseph D. Edwards

Messrs. Scott P. Crampton

Donald B. Craven

Daniel C. Perri

Meyer Rothwacks

Messrs. John L. Briggs

Oscar Blasingame

Messrs. Alfred Lombardi

Michael L. Paup

A-2

UNITED STATES DISTRICT COURT

MIDDLE DISTRICT OF FLORIDA

TAMPA DIVISION

No. 71-425-Civ-T-H

ST. PETERSBURG BANK & TRUST COMPANY,

Plaintiff,

vs.

UNITED STATES OF AMERICA,

Defendant.

OPINION

St. Petersburg Bank & Trust Company (the Bank)

instituted this suit pursuant to 28 USCA §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 certain

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

USCA §§ 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 shareholder, president and

chairman of the board of directors. From its inception the Bank

has aggressively and successfully sought out business from large

depositors, borrowers and settlors of trusts. Taking the view

that competition in the banking industry is largely confined to

the area of personal services and relationships, the Bank has

consistently endeavored to project the image of a local

institution offering friendly, efficient and personal services to

local businessmen, governmental entities and residents. Its

implementation of that concept has principally focused upon

and emphasized the management position of Hubert Rutland,

and virtually all of the Bank's public advertising has sought to

exploit both his professional and social reputation in the

community.

A-3

The expenses in dispute were incurred as a result of certain

cocktail and dinner parties held at the Rutland home in St.

Petersburg, and certain dove shoots and barbecues held at the

Rutland ranch in Manatee County, approximately 30 miles to

the South and East of St. Petersburg. 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. Attendance at these functions was by

invitation 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 outward 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 approbation of its

board of directors. The guest lists were compiled so as to

include customers or potential customers of the Bank, business

leaders, public officials, persons of substantial wealth and

others in a position to control large deposits or otherwise direct

beneficial 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 because they were Bank employees,

and many were specifically instructed to circulate among the

guests, pass out their business cards, and generally tout the

services of the Bank while nurturing a personal rapport with

established or potential customers. On several occasions the

employees took advantage of the opportunity to discuss specific

transactions, 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 shrewd and fully

justifiable expenditure by the Bank or its board of directors in

pursuit of economic 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

USCA $162) as interpreted and applied through 1962. See First

National Bank of Omaha vs. United States, 276 F.Supp. 905 (D.

Neb. 1967). The ultimate issue in the case, therefore, is the

proper construction to be made of Section 274 (26 USCA §274),

and a determination as to whether the subject expenses meet the

admittedly more stringent requirements of that provision.

A-4

Section 274 was added to the Code in 1962,* and its genesis

is best described in the Senate Committee Report:**

“The Treasury brought tc the attention 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 substantial tax-free

personal benefits on the recipients, and that in many

instances deductions are obtained by disguising personal

expenses as business expenses. He recommended that the

cost of such business entertainment and the maintenance of

entertainment facilities be disallowed in full as a tax

deduction and that restrictions be imposed on the deduct-

ibility of business gifts and travel expenses.

“Much of the abuse described by the President can be

traced to the broad judicial and administrative interpreta-

tion given to the term ‘ordinary and necessary’ which has

resulted in many entertainment expenses being allowed as

deductions where their connection with a trade or business

is quite remote. Under present laws, where a business

purpose, however slight, exists, then the entertainment

expenses generally are fully deductible if they are

‘ordinary and necessary’ business expenses.

“After careful consideration of the proposal, your

committee has concluded that deductions for entertain-

ment 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 business 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 entertainment. As it ultimately

evolved and became enacted, Section 274(a)(1)(A) provides as

follows:

* Revenue Act of 1962, Public Law 87-834, §4; 76 Stat. 960.

** S. Rep. No. 1881, 87th Cong., 2nd Sess. (1962); U.S. Code,

Congressional and Administrative News, 3304, 3327 (1962).

A-5

“$274. Disallowance of certain entertainment, etc.,

expenses

(a) Entertainment, amusement, or recreation. —

(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 constitute

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 tax-

payer's trade or business, . . .”

Careful reading of this provision discloses a rather curious

dichotomy of standards — “directly related” and “associated

with.” The statute clearly creates two classes of entertainment

expenses 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 conduct of the taxpayer's trade or business.” On the

other hand, in the case of an expense incurred for entertainment

“directly preceding or following a substantial and bona fide

business discussion,” it need only be “associated with” the

taxpayer's business in order to qualify for deduction.

The Bank contends, first, that on the peculiar facts of this

case the expenses involved easily qualify under the “directly

related” test and the Treasury Regulations expanding upon that

standard. Secondly, and alternatively, it contends that even if

the disputed expenses were not “directly related” to its business,

they surely qualify under the less exacting “associated with”

test. Inherent in the latver 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 discussions and the entertainment cannot be in process

simultaneously. To evaluate and resolve these issues it is

necessary to examine the legislative history of the statute in

—_—

A-6

depth and, to a lesser degree, the Treasury Regulations

promulgated since its enactment. *

I LEGISLATIVE HISTORY

As already noted, the purpose of Congress was to tighten

the existing law and prevent abuses that had developed under

Section 162. The President's recommendation 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 maintenance of

entertainment facilities in the absence of a clear showing that

such expense was “directly related” to the “active 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 disallowance as recommended by the

President 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.”

* * . *

“The House bill provides rules which in general

would: (1) disallow a deduction with respect to

entertainment activities, except to the extent that the

expense is directly related to the active conduct of a trade

or business; (2) disallow a deduction with respect to enter-

tainment facilities, unless the facility is used primarily for

* 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 basic or fundamental question.

Although the statute is now over 10 years old, only one recent decision has

approached the issue at hand, and it is clearly distinguishable. See

Hippodrome Oldsmobile, Inc. vs. United States, 474 F.2d 959 (6th Cir.

1973).

* S. Rep. No. 1881, 87th Cong. 2d Sess. (1962}; U.S. Code, Congressional

and Administrative News, , 3327-3329 (1962).

>

A-7

the furtherance of the taxpayer's trade of business and the

expense is directly related to the active conduct of the trade

or business; . . .”

“Your committee's bill to a considerable degree retains

the basic structure 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 established between the expense and the

active conduct of a trade or business.”

* * * *

“To eliminate the harshness resulting from the House

report, amendment of the language of the House bill is

necessary. Despite amendment of the House bill your

committee has made certain that entertainment expense

abuses are eliminated. By your committee's amendment an

alternative rule is added to the House bill under which

expenses for entertainment, amusement, or recreation

(with respect to both activities and facilities) also will be

deductible to the extent that such expenses are associated

with the active conduct of a trade or business. This new

language will permit deduction of expenses for entertain-

ment, amusement, or recreation incurred for the creation

or maintenance of business goodwill without regard to

whether a particular exception applies. However, this new

language will apply only if the taxpayer demonstrates a

clear business purpose and shows a reasonable expectation

of deriving some income or other benefit to his business

as a result of the expenditure. If he meets this test, the

expenditure will be considered to be associated 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 allowed 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 such expenses so long as they

A-8

were “associated with” the business and the taxpayer could

show “a reasonable expectation of deriving some income” as a

result of the expenditure. This was the posture of the bill,

therefore, as it proceeded to consideration by the conference

committee.

The report of the conference committee, and the language

of the statute as ultimately enacted, make it abundantly clear

that the view of the House prevailed, with one narrow

exception. The report states:*

“Senate amendments Nos. 29, 30 and 31 inserted the

words ‘or associated with’ after the words ‘directly related

to’ each place they appeared in the new section 274(a)(1) as

passed by the House.

“Under the conference agreement the House recedes on

Senate amendment No. 29 with an amendment providing

that deductions otherwise allowable under chapter 1 of the

code shall not be allowed for any item with respect to an

entertainment type activity ‘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.

Under the conference agreement, the Senate recedes on

amendment No. 30, and the House recedes on amendment

No. 31 with an amendment conforming to the action on

amendment No. 29.

“The rule of the House bill as described 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 deduction of expen-

ditures for entertainment occurring under circumstances

where there is little or no possibility of conducting business

affairs or carrying on negotiations or discussions relating

thereto, such as where the group of persons entertained is

large or the distractions substantial.

* II Conf. Rep. No. 2508, 87th Cong., 2d Sess. (1962); U.S. Code,

Congressional and Administrative News, 3732, 3735-3736 (1962).

A-9

“It is the understanding of the conferees, both on the

part of the House and the Senate, that the alternative

Senate ‘or associated with’ test as described in the report of

the Finance Committee would apply to certain entertaining

primarily to encourage goodwill where the evidence of

business connection is clear, whether or not business is

actually transacted or discussed during the entertainment.

The conference agreement would permit a deduction for

the cost of an entertainment item, even though the item is

not directly related to the active 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 discussion. The

conditions under which an item is ‘associated with’ the

active conduct of a trade or business are contained in the

report of the Committee on Finance. The deductibility of

other items of entertainment expense, as well as items with

respect to facilities, would be governed by the rule of the

House bill.

“Section 274(a) as agreed 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 evening entertains the

group and their wives at a restaurant, theater, concert, or

sporting event, such entertainment expenses, if associated

with the active conduct of the taxpayer's business, will be

deductible even though the purpose of the entertainment is

merely to promote goodwill in such business. Moreover, if

a group of business associates with whom the taxpayer is

conducting business meetings comes from out of town to

the taxpayer's place of business to hold substantial business

discussions, the entertainment of such business guests by

the taxpayer the evening prior to the business discussions

will be regarded as directly preceding the business

discussions.

“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 meetings (and their wives), such entertainment will be

considered as directly preceding or following a business

discussion.” (Emphasis supplied)

A-10

In summary, and as the enacted statute 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. vs. 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).”

Il THE DIRECTLY RELATED TEST

The Treasury Regulations promulgated under Section 274

generally restate the sense of Congress as revealed by the

committee reports. Thus, among other criteria not pertinent to

this case, Section 1.274-2(c)(3)(i)-(iv) of the regulations (26

C.F.R.) establishes four separate requirements, all of which

must be met for an entertainment item to qualify as a “directly

related” expense. Subsection (i) set forth the first of these

requjrements as follows:

(i) At the time the taxpayer made the entertainment

expenditure (or committed himself to make the expendi-

ture), the taxpayer had more than a general expectation of

deriving some income or other specific trade or business

benefit (other than the goodwill of the person or persons

entertained) at some indefinite future time from the making

of the expenditure. A taxpayer, however, shall not be

required to show that income or other business benefit

actually resulted from each and every expenditure for

which a deduction is claimed.”

(Emphasis supplied)

In addition, Section 1.274-2(c)(7) of the same regulation

(26 C.F.R.) provides:

(7) Expenditures generally considered not directly

related. Expenditures for entertainment, even if connected

with the taxpayer's trade or business, will generally be

considered not directly related to the active conduct of the

taxpayer's trade or business, if the entertainment occurred

under circumstances where there was little or no possibility

A-11

of engaging in the active conduct of trade or business. The

following circumstances will generally be considered

circumstances 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 substantial, 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)

Thus, insofar as the “directly related” test is concerned, it

seems manifest 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 derived from a purely social

setting and, as such, was precisely the type of expense

deduction hat Congress intended to eliminate by way of the

“directly related” test.

Ill TAE ASSOCIATED witH\Est

'

The above conclusions do not necessarily disqualify the

expenses, however, under the “associated with” test. That test,

as intended by the Senate, is sufficiently relaxed to

accommodate and allow deduction of certain goodwill items.

The regulations say (26 C.F.R. §1.274-2(d)(2)):

(2) Associated entertainment defined. Generally, any

expenditure for entertainment, if it is otherwise allowable

under chapter 1 of the Code, shall be considered associated

with the active 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

business relationship.”

The “associated with” test is limited, nevertheless, by the

express qualification, imposed in conference, that the expense

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

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echoing the views reflected in the conference committee report,

supra, the regulations provide (26 C.F.R. §1.274-2(d)(3)(ii)):

(ii) Directly preceding or following. Entertainment

which occurs on the same day as a substantial and bona

fide business discussion (as defined in subdivision (i) of this

subparagraph) will be considered to directly precede or

follow such discussion. If the entertainment and the

business discussion do not occur on the same day, the facts

and circumstances of each case are to be considered,

including the place, date and duration of the business

discussion, whether the taxpayer or his business associates

are from out of town, and, if so, the date of arrival and

departure, and the reasons the entertainment did not take

place on the day of the business discussion. For example, if

a group of business associates comes from out of town to

the taxpayer's place of business to hold a substantial

business discussion, the entertainment of such business

guests and their wives on the evening prior to, or on the

evening of the day following, the business discussion

would generally be regarded as directly preceding or

following such discussion.”

Since the “associated with” test is, in effect, an exception

and not a general rule, the applicability of the test to specific

facts is best determined when it is examined in juxaposition 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 social 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 relationship

to the business. On the other hand, when such affairs are

sponsored in conjunction 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 given in the Conference Report and the

Regulations, i.e. the familiar situations in which business

conferences are conducted by day and out of town participants

are entertained by night.

A-13

Viewed in this way, the conclusion is inescapable that the

Bank's disputed entertainment expenses also fail to satisfy the

requirements of the “associated with” test. It is not even

suggested by the Bank that the social gatherings were in any

sense an adjunct of formal business meetings. Rather, the Bank

insists that the “associated with” test should not be narrowly

confined to those precise situations in which the entertainment

literally “precedes” or “follows” substantial business dis-

cussions, and that expenses may still qualify for deduction

under that less demanding test even though the business

discussions 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 (quoted 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 “associated with” test was intended to apply to cocktail

and dinner parties, or dove shoots and barbecues merely

because some business is discussed and good will is promoted,

to what type of entertainment expense would the more

demanding “directly related” test ever be applicable? Further

exploration of that question here would require an indulgence

in conjecture concerning potential factual situations not yet

presented and unnecessary 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 within the scope of that test

would necessitate an unwarranted expansion of its limited area

at the expense of the primary “directly related” test and the field

it occupies.

The Clerk is directed to enter judgment in favor of the

Defendant, dismissing the complaint with costs to be assessed

according to law.

DONE and ORDERED at Tampa, Florida, this 27th day of

August, 1973.

W. Terrell Hodges

United States District Judge