Petition — OTM Corp. v. United States

Supreme Court, U. S$,

FILED

Sep 141978 |

IN THE

MICHABL RODAK, JR., CLERK

SUPREME COURT OF THE UNT TED SePAERS.

— FSe44ase

NO.

OTM CORPORATION,

Petitioner,

VS.

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

Dougal C. Pope

Attorney for Petitioner

2317 Bissonnet

Houston, Texas 77005

(713) 527-9325

INDEX

Page

Citations to Opinions Below......... 2

PURE OG COAG 6 06k. 66 6060 660d 66 bi Keb ee 3

Ren. PEGPOMCOE., oo sce cecccacucéue 4

DERCUCOS ZRVOLVEGs cc cwessocecbececes 5

Dee ccccecccosccecetecececeese 6

PP anéeddee bas senees owe ke dew ee 10

The Government was Required Under

Section 482 of the Internal Revenue

Code, 26 U.S.C. 482, to Allow as

Deductions to the Petitioner the

Equipment Rentals Which the

Petitioner Paid to a Related

Corporation (Tierco) Where The

Related Corporation Included Those

Payments in Its Income............ 10

ne ee See ne ek) eae 26

Corti tioate Of Gervaeds icucicceweses 27

ee

ee

LIST OF AUTHORITIES

Page

Cases:

Chared Corporation, Transferee,

v. U. S.

SOe Dem Pee. Se Geiss SPTAR accces 24

C.I.R. v. Duberstein

363 U.S. 278, 4 L.Ed. 1218,

SO Malthe BEES OeOe OHS ob cee eccce 24

C.I.R. v. First Security Bank of

Utah

92 S.Ct. 1085, 405 U.S. 394,

De eee a PE 6 bat cccclccecs 21

C.I.R. v. Newman

159 F.2d 818, 850-851 [35 AFTR

ye Se eee eee 22

C.I.R. v. Welch

345 P.uae Bane Se Gates: 19635)....-- 24

Karrell v. United States

181 F.2d 981 (9th Cir., 1950),

cert. denied, 340 U.S. 891,

a Beha: Bee we memes) 646..6.--.- 22

Monte Vista Lodge v. Guardian Life

Insurance Company of America

SBS Pua ‘eats Teste 95 -2967) 0 00 '2o 22

Smith-Bridgman & Co. v. Commis-

sioner

16 T.C. 287 (1951), Acquiescence

Cue BUM a eEe ehh ce we pecces 14-16

Tennessee-Arkansas Gravel Co. v.

Commissioner

RED Dawe We BEER D Beeeeccccccs 14-16

LIST OF AUTHORITIES (continued)

Page

Cases (continued):

United States v. United States

Gypsum Co.,

Rss.” es See > 6bb 6esae Se ae eee 23-24

Statutes:

ee. eee ee Ce ee 4c me's 6 batons 14,15,

21

aes as eG Ws oe oe ob wind ae 6 6's wrecel Oke 5,8-ll,

18,20,

re oe ke

25

a, Se aeaa SE a oe ob ae eo Ue we oO ak 4,5,8,

10,2),

13,14,

16-25

Be aan hee ee sae awn Se ecto kt ewaes 3

Regulations:

eS ge Ek 8 eee eas Sees Eisaee

16

Ria een SPR a S oe Skew eb be 0S 12

ee oe BS ety WP ee AR ee ee i’ Pee

Pe ee SS a ee er ey eee 13

—

LIST OF AUTHORITIES

(continued)

Miscellaneous:

Technical Information Release 838,

1966,

Rev.

Rul.

67-79,

Cumulative Bulletin 1967-l........

Page

IN THE

SUPREME COURT OF THE UNITED STATES

NO.

OTM CORPORATION,

Petitioner,

vs.

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

Petitioner prays that a Writ of Certio-

rari issue to review the Judgment of the

United States Court of Appeals for the Fifth

Circuit entered in the above entitled cause

on May 8, 1978.

CITATIONS TO OPINIONS BELOW:

The opinion of the District Court,

printed in Appendix A of the separate bound

Appendice, apparently is unreported. The

opinion of the United States Court of Appeals

for the Fifth Circuit is printed in Appendix

B of the separate bound Appendice and is

reported at 572 F.2d 1046.

JURISDICTION

The Judgment of the Circuit Court of

Appeals was dated May 8, 1978, and it

was entered on the same day.

The Order overruling the Motion for

Rehearing was dated June 27, 1978.

The jurisdiction of this Court is

invoked under 28 U.S.C. Section 1346.

m

QUESTION PRESENTED

Is the Government required under Section

482 of the Internal Revenue Code, 26 U.S.C.

482, to allow as deductions to the petitioner

the equipment rentals which petitioner paid

to a related corporation (TIERCO) where the

related corporation included these payments

in its income?

STATUTES INVOLVED

The Statutes involved are Section 482

and Section 162 of the Internal Revenue

Code of 1954, 26 U.S.C. Sections 162 and

482. These sections of the Internal Revenue

Code of 1954 are printed in Appendix C of

the separate bound appendice.

STATEMENT

This is a civil action for the recovery

of federal income taxes for the fiscal

years ended September 30, i955 through 1958.

The facts were stipulated in the Trial

Court.

OTM Corporation, the petitioner, here-

inafter called taxpayer, filed its claim

for refund for the years at issue and took

the position that it was entitled as deduc-

tions in computing its taxable income the

equipment rentals which it paid to a

related corporation, Texas Industrial

Equipment Rental Company (TIERCO). The

taxpayer's position was that under the

provisions of Section 482 and the regula-

tions thereunder that it was entitled to

these equipment rentals as a business

expense, since TIERCO had included these

payments in its income.

In the Trial Court, the parties stipu-

lated as to the reasonable rental value of

the equipment involved, and the taxpayer's

income taxes were recomputed based on this

stipulation and judgment was entered in

favor of the taxpayer for the sum of

$45,754.00, which represented a refund of

income taxes of $17,474.00, negligence

penalty of $654.00 and interest at

$27,626.00. In connection with the stipu-

lation, the taxpayer reserved the right to

present to the Trial Court the legal issue

of whether it was entitled to claim the

rest of the rental which it paid TIERCO as

a deduction since Internal Revenue Service

had not reduced the rental income of TIERCO

by the amount of the rent expense that

Internal Revenue Service had disallowed to

the taxpayer. Internal Revenue Service

taxed to TIERCO the amount that taxpayer

had paid it as rental income, but Internal

Revenue Service did not allow the taxpayer

a rental expense deduction for $74,224.08

which it had paid TIERCO during the years

at issue.

The Trial Court ruled that Section 482

did not apply to this case but that

Section 162 applied. Judgment was entered

accordingly. The dae of Appeals for the

Fifth Circuit sustained the Trial Court.

Section 162 in general allows as a

deduction only reasonable rental expenses.

The taxpayer's position is that Internal

Nieiiot Service disallowed part of the rent

which taxpayer paid to TIERCO, a related

taxpayer, because Internal Revenue Service

determined that the rents were not nego-

tiated on an arm's length basis. This is

an allocation of income or deduct’ons among

related taxpayers, and Section 482 applies.

However, Internal Revenue Service did not

reduce the rental income to TIERCO by the

amount of the disallowed rents to the tax-

payer even though the statute of limita-

tions applicable to TIERCO had not expired

at that time. Because of Internal Revenue

Service's own rulings and court decisions,

Internal Revenue Service cannot disallow

the rental deduction to the taxpayer,

because they did not reduce TIERCO's income.

The Government's position is that the rent

was disallowed under Section 162 and that

it was not required to make the correlative

adjustment to TIERCO's income.

ARGUMENT

THE GOVERNMENT WAS REQUIRED UNDER SECTION

482 OF THE INTERNAL REVENUE CODE, 26 U.S.C.

482, TO ALLOW AS DEDUCTIONS TO THE PETITIONER

THE EQUIPMENT RENTALS WHICH THE PETITIONER

PAID TO A RELATED CORPORATION (TIERCO) WHERE

THE RELATED CORPORATION INCLUDED THOSE

PAYMENTS IN ITS INCOME.

The issue is whether Section 482 or

Section 162 applies. The taxpayer contends

that Section 482 applies, whereas the

Government contends that Section 162 is

applicable.

Section 482 provides:

Sec. 482. Allocation of income and

deductions among

taxpayers.

In any case of two or more organi-

zations, trades, or businesses

(whether or not incorporated,

whether or not organized in the

United States, and whether or not

affiliated) owned or controlled

directly or indirectly by the same

interests, the Secretary may dis-

tribute, apportion, or allocate

gross income, deductions, credits,

or allowances between or among

such organizations, trades, or

businesses, if he determines that

such distributions, apportionment,

or allocation is necessary in order

to prevent evasion of taxes or

clearly to reflect the income of

-10-

any of such organizations, trades,

or businesses.

Section 162 provides:

Sec. 162. Trade or business expenses.

(a) In general.- There shall be

allowed as a deduction all the

ordinary and necessary expenses

paid or incurred during the taxable

year in carrying on any trade or

business, including--

* * * +

(3) rentals or other payments

required to be made as a condition

to the continued use or possession,

for purposes of the trade or busi-

ness, Of property to which the tax-

payer has not taken or is not taking

title or in which he has no equity.

x * * *

The taxpayer and TIERCO were related

entities.

The purpose of Section 482 is to place

a controlled taxpayer on a tax parity with

an uncontrolled taxpayer by determining

the true taxable income of the controlled

taxpayer; Reg. 1.482-1(b)(1). The Commis-

sioner has authority in determining the

correct taxable income of the controlled

@ii-

members to make such distributions, appor-

tionments, or allocations as he may deem

necessary of gross income, deductions,

credits, or allowances, or of any item or

element affecting taxable income, between

the controlled taxpayers and the standard

to be applied in every case is that of an

uncontrolled taxpayer dealing at arm's

length with another uncontrolled taxpayer;

Reg. 1.482-1(b) (1). The appropriate adjust-

ments may take the form of an increase or

decrease in gross income, increase or

decrease in deductions (including deprecia-

tion), or any other adjustment which may be

appropriate under the circumstances; Reg.

1.482-i(d) (1). Whenever the Commissioner

makes adjustments to the income of one

member of a group of controlled taxpayers,

he shall also make appropriate correlative

adjustments to the income of any other

member of the group involved in the alloca-

tion; Reg. 1.482-1(d) (2) (underscoring

«13-

supplied by taxpayer). An adjustment to

reflect an arm's length rental charge for

the use of the tangible property of a

member of a controlled group is included

in the provisions of Section 482; Reg.

1.482-1(a) (2), Example 1. Also see Reg.

1.482-2(c) (1) which says where one member

uses the tangible property of the other

member "without charge or at a charge

which is not equal to an arm's length

rental charge, the district director may

make appropriate allocations to properly

reflect such arm's length charge."

IRS recognizes the principle that if

an adjustment was made to the income of one

member of a controlled group that the

corresponding adjustment must be made to

the other member of the controlled group.

In other words, if the taxable income of

one member is increased, the taxable income

of the other member must be reduced by the

corresponding amount. In Technical

_—

Information Release 838, dated August 2,

1966, Rev. Rul. 67-79, Cumulative Bulletin

1967-1, page 117, IRS said:

"In cases where, pursuant to the pro-

visions of section 482 of the Internal

Revenue Code of 1954, the Service has

made adjustments to allocate income or

deductions among the members of a

group of business entities owned or

controlled by the same interests,

corresponding adjustments must be made

to the income or deductions of the

related corporations from which the

allocations were made."

In Rev. Rul. 67-79 IRS was explaining its

acquiescence in the decision of the Tax

Court of the United States in the case of

Smith-Bridgman & Co. v. Commissioner, 16

T.C. 287 (1951), Acquiescence C.B. 1951-1,

3; and its position on the decision of the

U. S. Court of Appeals for the Sixth

Circuit in the case of Tennessee-Arkansas

Gravel Co. v. Commissioner, 112 Fed.2d 508

(1940). In each of these cases, IRS had,

under the authority of Section 45 of the

Internal Revenue Code of 1939 (predecessor

of Sec. 482 of the 1954 Code), created

at8n

income where none existed under the provi-

sions of Section 45 of the Internal Revenue

Code of 1939. In the Smith-Bridgman & Co.

case, the taxpayer made interest free loans

to its parent company. IRS determined that

Smith-Bridgman & Co. had taxable income

equal to interest at 4% on these loans.

However, IRS did not allow the parent com-

pany an offsetting adjustment for this

interest expense.

In the Tennessee-Arkansas Gravel Co.

case, the taxpayer leased equipment to a

controlled corporation rent free. IRS

determined that the taxpayer corporation

should include in its income $12,000.

rental income which it determined was the

fair rental value of the equipment. How-

ever, IRS did not make the corresponding

adjustment and allow the controlled corpor-

ation the $12,000. rental expense. The

last paragraph of Rev. Rul. 67-79, Page 118,

says:

+=

Reg.

"The acquiescence in Smith-Bridgman &

Co. was intended only to concur in the

proposition that appropriate adjust-

ments are to be made to the incomes of

both members of the group affected to

reflect the allocation. The acquies-

cence does not override the Service's

position as to the scope and purpose of

section 482 of the 1954 Code as set

forth in existing regulations. Simi-

larly, the Service concurs in the

result reached in Tennessee-Arkansas

Gravel Co. only to the extent the

holding is based on its failure to

have made an appropriate adjustment

to the income or deductions of the

member of the group from which the

allocation was made."

1.482-1(b) (1) provides:

(b) Scope and purpose.

(1) The purpose af section 482 is to

place a controlled taxpayer on a tax

parity with an uncontrolled taxpayer,

by determining, according to the

standard of an uncontrolled taxpayer,

the true taxable income from the pro-

perty and business of a controlled

taxpayer. The interests controlling

a group of controlled taxpayers are

assumed to have complete power to

cause each controlled taxpayer so to

conduct its affairs that its trans-

actions and accounting records truly

reflect the taxable income from the

property and business of each of the

controlled taxpayers. If, however,

this has not been done, and the taxable

incomes are thereby understated, the

district director shall intervene, and,

by making such distributions, appor-

tionments, or allocations as he may

=16—

deem necessary of gross income,

deductions, credits, or allowances,

or of any item or element affecting

taxable income, between or among the

controlled taxpayers constituting the

group, shall determine the true taxable

income of each controlled taxpayer.

The standard to be applied in every case

is that of an uncontrolled taxpayer

dealing at arm's length with another

uncontrolled taxpayer.

IRS disallowed the rental deductions to

the taxpayer because IRS contends that the

payments which were made to the related

corporation, TIERCO, were excessive and

were not entered into in an arm's length

transaction. In enacting Section 482, Con-

gress intended to give IRS a weapon whereby

they could allocate income and deductions

among related taxpayers so that each would

report its true net income. However,

Congress wanted IRS to be fair about it and

not disallow deductions to one related tax-

payer where the correlative adjustment was

not made to the other related taxpayer.

This is exactly what IRS has done in this

Situation. Section 482 and the regulations

so Pe

thereunder prohibit such action on the part

of IRS. The rental deductions cannot be

denied to the taxpayer when the rental

income of TIERCO was not reduced by a

corresponding sum.

The Government's position is that the

disallowance of the rental expense was done

under the provisions of Section 162. Sec-

tion 162 is the general statute which pro-

vides that a business can deduct only ordi-

nary and necessary expenses. If a taxpayer

pays excessive rental to a related corpora-

tion, then the excess is not deductible

under Section 162 because the excess is not

an ordinary and necessary business expense.

However, in enacting Section 482,

Congress has provided a fair remedy to the

Government and to related taxpayers so that

if a related taxpayer pays excess rentals

that it will not be a "disallowed" deduction

as far as the related group is concerned.

Section 482 and the regulations thereunder

=e

provides that the excess will not be deduct-

ible by the payor provided that the income

of the related member receiving the excess

is reduced by the excess amount. If IRS

makes the correlative adjustment, then each

member of the related group will report its

correct taxable income. However, if IRS

does not make the correlative adjustment,

then Section 482 and the regulations there-

under provide that the excess rentals are

deductible by the payor or the taxpayer in

this case.

Taxpayer submits that it is not an easy

matter to know when a rental contract is

entered into the "fair rental value" of the

item of personal property involved. This

is an opinion matter and experts can and do

differ as to their opinion. Also, an

Internal Revenue Agent can have his opinion

and regardless of his qualifications or no

qualifications, the burden of proof is on

the taxpayer to prove him wrong. Therefore,

-19-

Congress, by enacting Section 482, wanted

to insure that if the taxpayer guessed

wrong Oc made a wrong decision as to the

"fair rental value", that the related group

would not pay tax on any more than the

total net income of the group. IRS has not

followed the mandate of Congress and its

own regulations because it has disallowed

as rental expense to the taxpayer the sum

of $74,224.08 and has not reduced the

rental income of TIERCO by that sum. The

net effect is that when this suit was

filed was that IRS had taxed the related

group of the taxpayer and TIERCO on

$74,224.08 more than their combined income.

This the Government is not permitted to do

under the provisions of Section 482.

As far as can be determined, this is

the first time that the Government has

taken the position that an excess deduction

taken by a related member is allowable only

under the provisions of Section 162. What

=20-<-

Opinion in Commissioner v. Newman, 159

F.2d 818, 850-851 [35 AFTR 857] (CA2

1947):

the Government is attempting to do is to

eliminate Section 482 from the Internal

""Over and over again courts have said

that there is nothing sinister in so

arranging one's affairs as to keep

taxes as low as possible. Everybody

does so, rich or poor; and ail do right,

for nobody owes any public duty to pay

more than the law demands: taxes are

enforced exactions, not voluntary con-

tributions. To demand more in the name

of morals is mere cant.'"

Revenue Code. Congress is the one to

eliminate a law and not IRS. Congress had

a purpose in enacting Section 482 and it

or its predecessors has been in the

Internal Revenue Code for a long time. As

stated by this Court in C. 3. R. v. First

Section 482 is a specific statute. Sec-

Security Bank of Utah, 92 S.Ct. 1085, 405

tion 162 is a general statute. The specific

U.S. 394, 31 L.Ed.2d 318 (1972), on page

statute should control over the general

1098, footnote 1:

statute unless Congress has indicated a

"1. Section 482 is not new. It appeared

as Section 45 of the Revenue Act of

1928, 45 Stat. 806, and has prede-

cessors in Sec. 240(f) of the Revenue

Act of 1926, 44 Stat. 46, and in

Section 240(d) of the Revenue Act of

1924, 43 Stat... 260."

clear intention otherwise.

Monte Vista Lodge v. Guardian Life

Insurance Company of America, 384 F.2d 126,

(C.A. 9, 1967) said on page 129:

In C.1I.R. v. First Security Bank of Utah,

. . «Fundamental maxims of statutory

construction require that a specific

section be found to qualify a general

section. A specific statutory provi-

sion will govern even though general

provisions, if standing alone, would

include the same subject. Karrell v.

United States, 181 F.2d 981 (9th Cir.,

1950), cert. denied, 340 U.S. 891, 71

§.Ct. 206, 95 L.8a. 646.”

supra, which was a Section 482 case, at

footnote 4, page 1089, this Court said:

u4 Taxpayers are, of course, generally

free to structure their business affairs

as they consider to be in their best

interests, including, lawful structuring

(which may include holding companies) to

minimize taxes. Perhaps the classic

example of this principle is Judge

Learned Hand's comment in his dissenting

22m

my se

The facts were stipulated in the Trial

Court.

The Trial Court found in its findings

of fact that the Government disallowed a

portion of the rental expense claimed by

the taxpayer under the provisions of

Section 162. Actually, this is a legal

conclusion or the ultimate conclusion on

which judgment was based in this case.

There is no evidence to support such a

conclusion. Taxpayer plead in his com-

plaint that Section 482 was applicable.

The Section 482 issue was preserved in

the pre-trial order under "contested

issues of law", which pre-trial order was

approved by the parties and it was

approved and entered by the Trial Court

on September 2, 1977. The findings by the

Trial Court that the Government used

Section 162 is clearly erroneous and the

ultimate legal conclusion in this case and

is reviewable by this Court. United States

o23@

v. United States Gypsum Co., 333 U.S. 364,

395; C.I.R. v. Duberstein, 363 U.S. 278,

4 L.Ed.2d 1218, 80 S.Ct. 1190, C.I.R. v.

Welch, 345 F.2d 939, (5 Cir., 1965),

Chared Corporation, Transferee, v. U. S.,

446 F.2d 745 (5 Cir., 1971).

It is the taxpayer's opinion that the

issue which is presented in this case is

of national importance in connection with

income tax matters. Most large and medium

sized businesses and many smaller businesses

are structured so that there are related

parties or businesses involved, and most of

these businesses deal with one another

where the provisions of Section 482 would

come into play. Many of these businesses

sell products to one another, rent equip-

ment to one another and engage in numerous

business activities between them. By the

use of Section 482, these businesses know

that if IRS determines that they did not

enter into a transaction on an arm's

o2§-

length basis and if IRS increases the income

of one member that IRS must make a correla-

tive adjustment and decrease the taxable

income of the other member. However, if

this case is allowed to stand, IRS will

have swept away Section 482 from the

Internal Revenue Code, and they will use

Section 162 on these type of cases. This

is going to leave uncertainty and confusion

among related or controlled entities, and

the litigation which this will entail will

be endless.

o25—

CONCLUSION

This Court should grant certiorari in

this case and reverse the judgments of the

Courts below.

Respectfully submitted,

Attorney for Appellant

2317 Bissonnet

Houston, Texas 77005

(713) 527-9325

o2f~

CERTIFICATE OF SERVICE

I hereby certify that I served copies

of the foregoing Petition for Writ of

Certiorari and the separately bound

Appendice on the several parties thereto

as follows:

1. On the United States by mailing a

copy ina duly addressed envelope with air

mail postage prepaid to the Solicitor General,

Department of Justice, Washington, D. C.

20530, and by mailing a copy in a duly

addressed envelope with air mail postage

prepaid to the Assistant Attorney General,

Tax Division, United States Department of

Justice, Washington, D. C. 20530.

Dated on this the 12th day of September,

1978.

Wid 2 Lb

Dougal &.° Pop’

>

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