Petition — Morton-Norwich Products, Inc. v. United States

Supreme Court brief1980

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Supreme Court, U. &

FILED

DEC 21 1979

: MICHABL ROBAK, JR., CLERK

Nn. %9-980

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1979

MORTON-NORWICH PRODUCTS, INC.,

Petitioner,

vs.

THE UNITED STATES,

: Respondent.

PETITION FOR WRIT OF CERTIORARI

TO THE

UNITED STATES COURT OF CLAIMS

Morgan J. Ordman

110 North Wacker Drive

Chicago, Illinois 60606

Of Counsel:

Frank R. Krok

Paul G. Simon

McBride, Baker, Wienke & Schlosser

110 North Wacker Drive

Chicago, Illinois 60606

December, 1979

INDEX

Page

Ce TT oa ahasa co cincc ciel chsesdeieccncceas l

ine an ccccacneaschsankenctinces 2

COU are uN Ba icon iccicicccicccscdeescdans 2

STATUTORY PROVISIONS INVOLVED........ 2

STATE ieee © Oe TERE CASE wovcnccccciccesperesceeesss: 5

REASONS FOR GRANTING THE WRIT....... 7

Co ccluancle 24

APPENDIX

A. Opinion of the Court of Claims............ la

B. Order Denying Petition for Rehearing Ib

CASES CITED

Alexander Proudfoot Company v. United States,

ul we Gk. Yi & Rl & Me | & ) Pee 6

Bardahl Manufacturing Corp. v. United States,

452 F.2d 604 (9th Cir. 1971) we 6. 12

Bardahl Manufacturing Corp. v. United States,

70-1 U.S. Tax Cas. 99105 (W.D. Wash.

Prat ie a RR El ce SEN SRR lon AD ab 6, 12

Hart Metal Products Corp. v. United States, 76-2

US. Tax Cos. Forel (Ce Cl P9768) .....:...5.:5:.... 16

Interstate Fire Insurance Co. v. United States,

215 F.Supp. 586 (E.D. Tenn. 1963), aff'd.

339 F.2d 603 (6th Cir. 1964) oe 19, 20

J. O. Johnson, Inc. v. United States, 73-1 U.S.

Waa Ce ete CCE. OA FITS D wvcnvnsciccescostvicceese 22 \

Loper Lumber Co. v. United States, 444 F.2d

pe RARER name nae 6, 14, 20

Motor Fuel Carriers, Inc. v. United States, 420

ke tee ee Re, 2 WER sree ae ey ey 8

13, 14, 15,

16, 20, 21,

22, 23, 24

Myron’s Ballroom v. United States, 382 F.Supp.

582 (C.D. Cal. 1974), rev'd on other grounds,

sub. nom., Myron’s Enterprises v. United °

States, 548 F.2d 331 (9th Cir. 1977) 0... 6

STATUTES CITED

IRAN SMa BURA: dissktesedesphaisubpiush sncepeloa ens clidacidsecs 2

MRNA RITE Cinagabsstitaciactasiosssanpiuacaiuesigareeesnyacs 6

DN MRE cae ok oh stoacnsccdsch easeydnconnsvosavccedibgatanbeensaicadins 21, 22

STE acldvaste-\autiansidiandinsinciasekbreceaiearbarep anatomic: be Dy Oy 1,

11, 16, 17

18, 19, 20,

: 24,22; 23

RE NIE ices asia Abend cnsosncickn shilawassnsdasebieapgspiosadnaes 2; 3, F822,

NN ri soe ics ons seals cccayecensSinsincaeevnnneseises 23

UP PREM PYF osccscassensiscsosiseksscdadasasoane snpstarostevabes P

RID i kc sccbiticesh dence anatsiveknaceinciarbnntamociecdis oe ivep?

SN I setsN usu ctitncdecdabenpcpkstssoddnascoctavesicessnine 3,11

ie, SG ects cca as vk vo dk cadunpasbnlivseedbabidvons a; 8, 40, 3,

12, 15, 21,

Ne csi a shia sanespccnidealaghstcivaavsucehcns 4, 10

EE RC OB i oases cali da cccmenscespsenenneiacsisvenncigase 4, 10

REI FE Bo soso atpecsadadecnsenssvscessntcanitdannines 14, 16

PR EG IESE iscecsdespdariaccassatincivssic tener etitaws 4,11, 12, 13

ADDITIONAL AUTHORITIES CITED

Revenue Rulings

Rev. Rul. 66-237, 1966-2 C.B. 508..................00c00050. 12

POV. Puhr ee, 1972418 CB. S99 ois cccscessccacscuss 12

Treasury Regulations

Treas. Reg. §1.482-1(b)(3) (1968)... 19

Treas. Reg. §1.482-2(a)(1) (1968) woe. 23

Treas. Reg: $1.482-2(e) ( 1968) ...;.................ecesec00e. 23

No.

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1979

MORTON-NORWICH PRODUCTS, INC.,

Petitioner,

vs.

THE UNITED STATES,

Respondent.

PETITION FOR WRIT OF CERTIORARI

TO THE

UNITED STATES COURT OF CLAIMS

Petitioner Morton-Norwich Products, Inc. (hereinafter re-

ferred to as ““Morton-Norwich”) prays that a writ of certiorari

issue to review the judgment of the United States Court of

Claims entered in the above-entitled case on July 18, 1979,

which judgment became final upon denial of the petition for

rehearing on September 28, 1979.

OPINIONS BELOW

The opinion of the United States Court of Claims is set

forth in Appendix A ard is reported at 602 F.2d 270. The

Court of Claims denial of Morton-Norwich’s petition for

rehearing en banc is set forth in Appendix B.

JURISDICTION

The opinion of the United States Court of Claims was filed

on July 18, 1979. Appendix A. A petition for rehearing en banc

was filed with the United States Court of Claims and was

denied on September 28, 1979. Appendix B. This petition for

writ of certiorari invokes the Court’s jurisdiction under 28

U.S.C. § 1255(1).

QUESTION PRESENTED

Whether interest on a deficiency in federal income tax

which has resulted from an exercise of discretion by the

Government under Section 482 of the Internal Revenue Code

of 1954, as amended, should commence on the relevant income

tax return due date or, as contended by Morton-Norwich, on

the date of notice and demand for payment of the tax.

STATUTORY PROVISIONS INVOLVED

I.R.C. Sec. 531. IMPOSITION OF ACCUMULATED EARNINGS TAX.

In addition to other taxes imposed by this chapter, there is

hereby imposed for each taxable year on the .accumulated

taxable income (as defined in section 535) of every corporation

described in section 532, an accumulated earnings tax equal to

the sum of—

(1) 27% percent of the accumulated taxable income

not in excess of $100,000, plus

(2) 38% percent of the accumulated taxable income in

excess of $100,000.

I.R.C. Sec. 482 (as amended). ALLOCATION OF INCOME AND

DEDUCTIONS AMONG TAXPAYERS.

In any case of two or more organizations, trades or

businesses (whether or not incorporated, whether or not or-

ganized in the United States, and whether or not affiliated )

owned or controlled directly or indirectly by the same interests,

the Secretary or his delegate may distribute, apportion, or

allocate gross income, deductions, credits, or allowances be-

tween or among such organizations, trades, or businesses, if he

determines that such distribution, apportionment, or allocation

is necessary in order to prevent evasion of taxes or clearly to

reflect the income of any of such organizations, trades, or

businesses.

I.R.C. Sec. 6151 (as amended). TIME AND PLACE FOR PAYING

Tax SHOWN ON RETURNS.

(a) General Rule.—Except as otherwise provided in this

section, when a return of tax is required under this title or

regulations, the person required to make such return shall,

without assessment or notice and demand from the Secretary,

pay such tax to the internal revenue officer with whom the

return is filed, and shall pay such tax at the time and place fixed

for filing the return (determined without regard to any exten-

sion of time for filing the return).

I.R.C. Sec. 6155. PAYMENT ON NOTICE AND DEMAND.

(a) General rule.—Upon receipt of notice and demand

from the Secretary or his delegate, there shall be paid at the

place and time stated in such notice the amount of any tax

(including any interest, additional amounts, additions to tax,

and assessable penalties) stated in such notice and demand.

* * *

I.R.C. Sec. 6601 (as amended). INTEREST ON UNDERPAYMENT,

NONPAYMENT, OR EXTENSIONS OF TIME FOR PAYMENT, OF TAX.

(a) General Rule.—If any amount of tax imposed by this

title (whether required to be shown on a return, or to be paid

by stamp or by some other method ) is not paid on or before the

last date prescribed for payment, interést on such amount at an

annual rate established under Section 6621 shall be paid for the

period from such last date to the date paid.

x * *

(b) Last Date Prescribed for Payment.—For purposes of

this section, the last date prescribed for payment of the tax shall

be determined under chapter 62 with the application for the

following rules:

* * *

(4) Last Date For Payment Not Otherwise Pre-

scribed.—In the case of taxes payable by stamp and in all

other cases in which the last date for payment is not

otherwise prescribed, the last date for payment shall be

deemed to be the date the liability for tax arises (and in no

event shall be later than the date notice and demand for

the tax is made by the Secretary).

* * *

(e) Applicable Rules.—Except as otherwise provided in

this title—

* * *

(3) Interest on Penalties, Additional Amounts, or

Additions to the Tax.—Interest shall be imposed under

subsection (a) in respect of any assessable penalty, addi-

tional amount, or addition to the tax only if such assessable

penalty, additional amount, or addition to the tax is not

paid within 10 days from the date of notice and demand

therefor, and in such case interest shall be imposed only for

the period from the date of the notice and demand to the

date of payment.

STATEMENT OF THE CASE

Morton-Norwich Products, Inc. and its predecessor corpo-

rations (“Morton-Norwich”) made loans and advances to

certain foreign subsidiaries over a period of years. Morton-

Norwich charged its subsidiaries no interest on these loans and

advances. The Government, pursuant to Section 482 of the

Internal Revenue Code of 1954, as amended (the “Code”’),

imputed interest income to Morton-Norwich commencing with

its tax year ending December 31, 1965, through the year ending

June 30, 1973, inclusive. Morton-Norwich refused to consent to

the Commissioner’s action, and filed petitions with the United

States Tax Court challenging said deficiencies with respect to

certain of the tax years and periods involved. Morton-Norwich

and the Government commenced settlement negotiations with

respect to the Section 482 issue for all the above years.

Prior to final settlement of the case, the United Court of

Claims, in Motor Fuel Carriers, Inc. v. United States, 420 F.2d

702 (Ct. Cl. 1970), decided, in context of the accumulated

earnings tax (Sections 531 through 537 of the Code), that since

the exercise of discretion by the Government is the liability

generating event under Section 531, no liability existed until the

Government exercised that discretion. Taxpayer had no right,

duty, or obligation to report the tax. Accordingly, it was held

that under the relevant statutory interest provisions, interest on

the deficiency attributable to the discretionary action of the

Government under Section 531 could commence only upon

receipt of notice and demand for payment of the tax, the date

the liability vested, and not on the due date of the return. Since

the taxpayer could not report tax which did not exist on the

return due date, there being no obligation for tax at that time,

the statutory interest provisions premised upon deficiencies in

tax which should have been shown on the return were held not

to apply. Subsequent to Motor Fuel Carriers, numerous

additional decisions unanimously adopted the Court of Claims

holding in the accumulated earnings tax context including

decisions by the Sixth and Ninth Circuit Courts of Appeal.1

Since tax attributable to a Section 482 allocation is depen-.

dent upon discretionary action by the Government just as is tax

attributable to accumulated earnings, and since a taxpayer is

precluded from reporting tax under Section 482 to the same

extent that a taxpayer is precluded from reporting accumulated

earnings tax, and based upon the compellingly consistent line of

Federal case authority in the latter context, Morton-Norwich

and the Government settled the Section 482 issue in a manner

which preserved Morton-Norwich’s rights to file refund claims

with respect to the settlement deficiency interest paid, which

interest totalled $792,164. Morton-Norwich filed refund

claims, which were denied by the Government, and Morton-

Norwich instituted suit for refund in the United States Court of

Claims pursuant to 28 U.S.C. 1491. Other issues which are not

relevant here were and continue to be involved in the refund

suit.

Morton-Norwich and the Government filed cross motions

for summary judgment in the Court of Claims proceeding. A

divided three-judge panel of the Court of Claims found in favor

of the Government on the present issue and remanded the

unrelated issues for further proceedings. Judge Bennett wrote

the majority opinion, in which Judge Kunzig joined. Judge

Nichols dissented in part.

' See Loper Lumber Co. v. United States, 444 F. 2d 301 (6th Cir.

1971); rev’g unreported District Court opinion; Bardahl Manufac-

turing Corp. v. United States, 452 F. 2d 604 (9th Cir. 1971), rev’g 70-

1 US. Tax Cas. 79105 (W. D. Wash. 1969). See also Myron’s

Ballroom v. United States, 382 F. Supp. 582(C. D. Cal. 1974), rev'd

on other grounds, sub. nom., Myron’s Enterprises v. United States, 548

F. 2d 331 (9th Cir. 1977). Additionally, the Court of Claims, in

Alexander Proudfoot Co. v. United States, 454 F. 2d 1379 (Ct. Cl.

1972), stated that it had followed Motor Fuel Carriers by orders

entered in some thirty-three other cases. 454 F. 2d at 1385.

ee ee ee ee eee

ee eee

The majority opinion, after characterizing Morton-

Norwich’s argument as presenting “‘an important issue of first

impression” (App. 2a), decided in favor of the Government

without adequately reconciling or directly addressing the

important premises upon which the existing case law was

based. Judge Nichols, in his separate opinion which dissented

in material part from the majority opinion, stated that he had

originally written his opinion “in hopes of its being accepted as

a majority opinion” (App. 12a), and viewed the majority

opinion as a “simplistic” one. (App. lla). Morton-Norwich

filed a motion for a rehearing en banc, which motion was

denied.

REASONS FOR GRANTING THE WRIT

We recognize that, as a statistical matter, the Court does

not often exercise its supervisory powers in Federal income tax

matters. The “exception should prove the rule” here. We

would note the following:

1. The issue presented is not only a novel issue, but

one of compelling interest to taxpayers and their repre-

sentatives. Unlike the typical income tax case, which often

is of relatively narrow applicability and offers minimal

doctrinal ‘‘excitement’”’, this issue is quite the reverse here.

The logic of the application of the Motor Fuel Carriers line

of authorities to other areas of the tax law and, in

particular, to Section 482 tax deficiencies, is compelling.

2. The issue presented here is not only novel, but one

of enormous significance to the Treasury and to effective

income tax administration. While we do not have access to

information describing the aggregate amount of interest

paid with respect to Section 482 deficiencies, the amounts

are substantial. Furthermore, the principles set forth

herein could logically extend beyond Section 482 to other

areas of the tax law.

3. The issue, at this point, has not been finally decided

and, in fact, the state of the law is confusion. The statutory

interest provisions are clearly supportive of Morton-

Norwich’s position. Motor Fuel Carriers was decided by

the Court of Claims en banc, and has been adopted by the

Sixth and Ninth Circuit Courts of Appeal. Only a divided

panel of the Court of Claims is responsible for reversing

the doctrine heretofore established, and the doctrinal

reversal has occurred in a manner which has not addressed

the principles upon which the pre-existing authorities were

premised.

The combination of the novelty and general interest

presented by this issue, its enormous fiscal implications, and

what Petitioner submits to be the serious conflict created by the

divided panel’s opinion, virtually assures that the issue will arise

in many contexts, and in many jurisdictions, in the near future.

There is, further, little doubt of the likelihood that there will be

a substantial disparity and inconsistency in future court deci-

sions. The resulting effect upon judicial economy and adminis-

tration and the implications to the Treasury will be substantial

and adverse.

Accordingly, Petitioner submits that for the foregoing

reasons, the issue is one with respect to which the need for this

Court to exercise its supervisory powers will soon be clear.

Petitioner submits the time for the Court to exercise such

powers is now—before the above consequences are manifest.

The Federal system of taxation relies heavily upon each

taxpayer completely and accurately reporting its income tax

liabilities on a timely basis. Governmental reliance upon

proper reporting by taxpayers results in the system often being

properly and timely report its income on its return, and to pay

referred to as “gelf-assessing”. The taxpayer is expected to

the tax shown ie than the return’s due date.

The self-reporting philosophy is reflected in the Code

provisions governing interest on tax underpayments. As will be

demonstrated below, the liability for reportable taxes, for

interest computation purposes, accrues on the date the return is

due. If the taxpayer should have reported more tax, interest

does not run from the time liability for the additional tax is

ultimately adjudicated, but from the time that tax should have

been reported and paid. If, however, the reporting of tax is

neither required nor permitted, relevant Code provisions pro-

vide that interest commences, not with the filing of the return,

but upon the date the liability for tax arises. As demonstrated

by the Motor Fuel Carriers line of cases, an interest obligation

premised upon the self-reporting philosophy does not extend to

a situation in which tax cannot be self-reported and in which an

exercise of Governmental discretion is the condition precedent

to the very existence of the liability for tax at issue.

Tax liability resulting from an allocation under Section 482

cannot be reported by a taxpayer, because discretionary action

by the government is the liability-generating event. Since

liability for tax vests only at such time as governmental action

has resulted in an enforceable tax consequence, Plaintiff main-

tains that interest may commence oply at that time. This

conclusion is supported by: the relevant Code provisions gov-

erning interest on tax (discussed in Part A)?; the Motor Fuel

Carriers line uf authority (discussed in Part B); and the clear

application of the foregoing to the rationale of Section 482

2 Various of the Code provisions cited in this part were modified,

during the time period here involved, in respects not material to the

legal issue. For clarity in discussion, the version of the Code

provisions after the effective date of P. L. 93-625 (July 1, 1975) are

used in the text below.

(discussed in Part C). Finally, the clearly erroneous decision of

the Court of Claims below is discussed in light of the statutory

and case law principles (Part D).

Under Applicable Code Provisions, Interest On Tax

Which Is Not Reportable On A Return Commences On The

Date Of Notice And Demand For Such Tax, And Not With

The Due Date Of The Return.

Section 6601(a) of the Code provides that interest must be

paid on tax from the last date prescribed for payment of the tax

to the date paid. Section 6601( b) provides that “the last date

prescribed for payment of the tax” is to be determined under

chapter 62 of the Code, with the application of various rules

contained in Section 6601(b). Relevant here is Section

6601(b)(4), which states that if the last date for payment is not

otherwise prescribed, the last date for payment is the date the

liability for tax arises, which shall not be later than the date

notice and demand for the tax is made.

Chapter 62 of the Code (Sections 6151 through 6157),

entitled “Time and Place for Paying Tax”, prescribes the last

date for payment of tax, that date, again, being the interest

commencement date under the general rule of Section 6601 (a).

Section 6151, entitled “Time and Place for Paying Tax Shown

on Returns”, reads pertinently as follows:

(a) GENERAL RULE.—Except as otherwise provided in this

subchapter, when a return of tax is required under this title

or regulations, the person required to make such return

shall, without assessment or notice and demand from the

Secretary, pay such tax to the internal revenue Officer with

whom the return is filed, and shall pay such tax at the time

and place fixed for filing the return (determined without

regard to any extension of time for filing the return).

ILR.C. § 6151(a) (emphasis added ).

174s aiaehtartbati os tn nine epaoen ise”

Section 6155(a) provides that upon receipt of notice and

demand from the Secretary, the amount of any tax therein

stated shall be paid. No other section of Chapter 62 bears upon

the issue.

The general rule set forth in Section 6601(a) is limited by

the special rule of Section 6601(e)(3), which provides that

interest in respect of any assessable penalty, additional amount,

or addition to the tax runs only if the amount is not paid within

10 days from the date of notice and demand therefor, and the

interest accrues in such case from the date of notice and

demand.

The above statutory provisions are the basis for Petitioner’s

position. In capsule form, if'a tax is viewed as a penalty,

interest commences with the date of notice and demand for

payment of the tax. Otherwise, interest runs from the last date

prescribed for payment of the tax. That date is the date fixed

for filing the return only “when a return of tax is required.”

Section 6151(a). When a return of tax is not required, the due

date of the return has no significance. In such a case, the last

date prescribed for payment is the date of notice and demand

for payment of the tax.

The Case Law Confirms That If Taxpayer Cannot Report

A Tax, And If Liability For The Tax Requires Action By The

Government, Interest Commences Upon Notice And Demand

For Payment.

The case law construing the above-discussed Code provi-

sions clearly establishes that interest on tax which cannot be

reported should not be premised upon a reporting obligation,

but should commence to run with the date of notice and

demand for payment. While the case law has been pre-

dominantly in the context of determining interest on accumu-

lated earnings taxes imposed under Section 531, as will be seen

below, the controlling principles are fully applicable to interest

on tax resulting from the Government’s exercise of discretion in

making a Section 482 allocation.

The Court of Claims decision in ‘Motor Fuel Carriers, Inc.

v. United States, 420 F.2d 702 (Ct. Cl. 1970), is the watershed?

case in the development of the now-established principle that

interest attributable to an accumulated earnings tax assessment

commences with the date of notice and demand for payment.

Taxpayer in Motor Fuel Carriers was assessed deficiencies

which included additional tax unc~r Section 531, and interest

thereon, from the due date of its return. Taxpayer paid all

amounts alleged due and sued to recover the tax attributable to

the accumulated earnings adjustments. After judgment was

returned for the Government, taxpayer filed a refund claim for

interest paid with respect to the accumulated earnings tax, and

after rejection of the claim, filed suit for refund in the Court of

Claims. The Court concluded that interest commenced on the

date of notice and demand, basing its decision on the alterna-

tive grounds that (1) the accumulated earnings tax is an

‘assessable penalty, additional amount or addition to the tax”

within the meaning of Section 6601(e)(3)4, hence governed by

the specific provisions thereof; and (2) assuming applicability

of the general rule of Section 6601(a), the “last date prescribed

for payment” was the date of notice and demand for payment.

3 Motor Fuel Carriers was preceded by Rev. Rul. 66-237, 1966-2

C. B. 508, and Bardah!l Manufacturing Corp. v. United States, 70-1\

U.S. Tax. Cas. 79105 (W. D. Wash. 1969), each of which held that

interest commenced with the due date of the return. Subsequent to

Motor Fuel Carriers, Rev. Rul. 66-237 was revoked (Rev. Rul. 72-

324, 1972-1 C. B. 399), and Bardahl was reversed ( 452 F. 2d 604, 9th

Cir. 1971). A consistent line of authority adopting Motor Fuel

Carriers followed. See footnote 1.

4 The Section was redesignated, effective July 1, 1975, as Section

6601(e)(3) by P.L. 93-625, § 7(b)(1). Other technical changes

made were of no substantive import. The Section was previously

Section 6601(f)(3).

While the Court decided on dual grounds, the reasoning

underlying each was that since the accumulated earnings tax is

not reported, but requires action by the Government to gener-

ate the liability, the date the return was due had no significance

for interest computation purposes.

The first-discussed basis for decision was that Section

6601(e)(3) controlled. The Court did not find technical

arguments made either by the Government or the taxpayer to

be controlling. Rather than resort to a technical basis for

decision, the Court stated:

Given the breadth of the phrasing of § 6601(f)(3), we

think that the proper way to interpret the provision is to

seek the reason why—for the subsection, in contrast to

other interest provisions—interest is allowed to run only

after notice and demand, and not from an earlier time.

420 F.2d at 707.

In analyzing “why”, the Court continued:

It seems plain that the answer lies in the need, in these

instances, for an administrative determination by the Ser-

vice. The factor common to the chapter 68 items which

§ 6601(f)(3) admittedly covers... is that a Service

determination precedes the imposition of those penalties

and additions. The taxpayer knows that he has to pay

because the Service tells him so; these are not items which

are treated as self-assessable or which the taxpayer is

expected to remit before demand is made. In other words,

we infer that § 6601(f)(3) covers those “extra” payments

or sanctions which the taxpayer can properly wait for the

Service to determine and invoke, and which he need not

himself include in his tax return.

As we have indicated, the accumulated earnings tax falls

into this class of additional payments. A taxpayer can

properly file its corporate return without paying any atten-

tion to this tax; in so doing it will not make any erroneous

or false statement nor will it leave its return with any

omission or gap.... The reason is, of course, that an

administrative decision is the normal precondition.

420 F.2d at 707. (emphasis added )

Finally the Court rejected the Government’s attempted

analogy between the personal holding company tax and the

accumulated earnings tax:

Finally, defendant’s analogy to the tax on personal holding

companies (26 U.S.C. §§ 541-547) is unpersuasive; that

tax is reportable on the return, is meant to be so reported,

and is treated as self-assessable.

420 F.2d at 708.

The same line of reasoning was cited in support of the

Court’s alternative basis for decision that under Section

6601(a), the “last date prescribed for payment” was the date of

notice and demand for payment:

Since, as we have pointed out, the accumulated earnings

tax is not reportable on any return, but rather “result(s ]

from the initiative of the tax collector and not, as is more

usual with other income taxes, from the initiative of the

taxpayer” (Govt. Br. at 5), it follows that this tax becomes

payable only upon notice and demand by the Internal

Revenue Service. For that reason, the part of chapter 62

we deem applicable is § 6155... .

420 F.2d at 708.

On such alternate basis, interest was held to have commenced

on the date of notice and demand.5

The initiative shown by the Court of Claims was followed

by the other courts faced with the issue® and, ultimately, was

even accepted by the Internal Revenue Service.” Since Loper

6 The taxpayer and the Government assumed that § 6601(c)(4)

(“Last date for payment not otherwise prescribed”) would apply if

plaintiff prevailed. The result, however, would have been the same.

See, Loper Lumber Co. v. United States, 444 F. 2d 301 (6th Cir.

1971).

® See, for example, footnote 1, supra.

7 See footnote 2, supra.

Se a ee |e ce meheen

Lumber Co. v. United States, 444 F.2d 301 (6th Cir. 1971), is

the only case further elaborating upon the Motor Fuel Carriers

rationale, only that opinion is discussed here.

After setting forth the facts, and the Government’s reliance

on Section 6601(a) as controlling, the Sixth Circuit in Loper

viewed the determinative issue to be the definition of the “last

date prescribed for payment”. In addressing the issue the court

again stressed the inability to self-report an accumulated earn-

ings tax liability, quoting extensively from the Court of Claims

in Motor Fuel Carriers. 444 F.2d at 303. In rejecting

application of the “general rule” that the due date of the return

was the last date prescribed for payment in the case of a non-

reportable tax, the court followed the Motor Fuel Carriers line

of analysis in stating:

We do not consider this general rule to be applicable in the

present case since no return of tax is required on the part of

the taxpayer in connection with the accumulated earnings

tax. We read the general rule of § 6151 (a) as designed to

cover only the ordinary tax situation in which the taxpayers

are required to file a return showing the tax calculated as

due and owing, and not the situation here involved in which

the Commissioner, not the taxpayer, calculates the tax.

This distinction is highlighted by the title of § 6151: “Time

and place for paying tax shown on returns.” (emphasis

added) While taxpayers would not be entitled to a refund

of interest if they had merely “undercalculated” a tax that

was self-assessing and shown the undercalculated amount

on their returns, United States v. Northwestern Mutual Ins.

Co., 315 F.2d 723 (9th Cir.), §6151(a) at the most is

limited to taxes which are shown or “showable” on a

return. The Commissioner does not provide a method by

which taxpayers can calculate the accumulated earnings

tax nor does he provide a form or “return” on which to

report the tax. We therefore conclude that § 6151 is not

applicable here.

444 F.2d at 304. (emphasis added )

Having fully adopted the Motor Fuel Carriers rationale to

limit Section 6151 to tax that may be reported, the court held

the date of notice and demand to be the controlling date under

Section 6601(c)(4).

Only one case has involved an attempt to apply the Motor

Fuel Carriers rationale to a situation other than an accumulated

earnings tax deficiency. In Hart Metal Products Corp. v. United

States, 76-2 U.S. Tax Cas. 99781 (Ct. Cl. 1976), taxpayer

asserted that interest on a personal holding company tax

deficiency was within the rationale of Motor Fuel Carriers. The

Court of Claims properly rejected the argument, emphasizing

the self-reporting basis of its Motor Fuel Carriers opinion, and

Stating:

We held, however, in Motor Fuel Carriers (citation

omitted ) that § 6601(f)(3) applies only to such additions

which need an administrative determination by the Service

before the taxpayer can know that he is liable for them.

We also indicated explicitly that the personal holding

company tax (unlike the accumulated earnings tax) falls

outside that category; “that tax (i.e., the personal holding

company tax) is reported on the return, is meant to be so

reported, and is treated as self-assessable.” (citation

omitted). A taxpayer is clearly required to report (on its

return) personal holding company income and to pay the

personal holding company tax with its return.

76-2 U.S. Tax Cas. at 85,537.

The foregoing authorities demonstrate with consistency

that if a tax must await a determination by the Government,

and is unreportable by taxpayer, the due date of taxpayer’s

return has no significance in computing interest. Simply stated,

on the basis of common sense alone, an obligation to pay

interest premised upon failure to properly report a tax does not

logically extend to tax which cannot be reported.

The analysis underlying the reasoning of the courts as

outlined above is fully applicable to any non-reportable tax, the

liability for which arises as a result of governmental action. As

is demonstrated in the following discussion, tax resulting from a

Section 482 allocation is such tax.

eee

rate ey at

Since A Tax Imposed As A Result Of A Section 482

Allocation Cannot Be Reported By A Taxpayer, But Requires

A Prior Exercise Of Governmental Discretion, Interest Com-

mences Only After Liability For The Tax Arises, And Not

Upon The Filing Of The Return.

There is no liability for tax resulting from a Section 482

allocation until the government, through discretionary action,

determines that a liability exists, and the liability results in an

enforcible tax consequence. The above conclusion is mani-

fested in the language of Section 482, its legislative history, the

Government’s own regulations, and the case law, and there is

no room for a contrary interpretation. As such, the statutory

framework discussed in Part A and the case law as discussed in

Part B are fully applicable to tax resulting from a discretionary

Section 482 adjustment.

Section 482 reads, in full text, as follows:

In the case of two or more organizations, trades, or

businesses (whether or not incorporated, whether or not

organized in the United States, and whether or not affil-

iated) owned or controlled directly or indirectly by the

same interests, the Secretary may distribute, apportion, or

allocate gross income, deductions, credits, or allowances

between or among such organizations, trades, or business-

es, if he determines that such distribution, apportionment,

or allocation is necessary in order to prevent evasion of

taxes or clearly to reflect the income of any of such

organizations, trades, or businesses.

I.R.C. § 482. (emphasis added )

As demonstrated by the emphasized language, the making

of a Section 482 adjustment is completely discretionary with the

Secretary. Implicit in that language is the fact that even “‘if [the

Secretary ] determines that” an adjustment under Section 482 is

required, “the Secretary may,” but need not, make such adjust-

ment. There is no obligation placed upon the Secretary to

make an adjustment. Nor is there any power given to the

taxpayer to take, or to require the Secretary to take, any such

action. If the Secretary does not make a Section 482 allocation,

whatever the reason, there is no liability for the tax.

The legislative history of Section 482 demonstrates that the

above pattern is purposeful. Section 482 originated as Section

240(d) of the Revenue Act of 1921, which was an adjunct of

the consolidated return provisions, and gave the Commissioner

the power to consolidate the accounts of related trades or

business in certain instances. Section 240(d) was amended, as

part of the Revenue Act of 1924, to provide that “the Commis-

sioner may and at the request of the taxpayer shall’ consolidate

accounts in such cases. As a result of the 1924 Act, the taxpayer

had the power to invoke the statutory predecessor of Section

482. Section 240(d) was re-enacted as Section 240(f) of the

Revenue Act of 1926. 44 Stat. 46.

Section 240(f) became Section 45 of the Revenue Act of

1928, with various significant changes. First, the statute spoke

in terms of the power to “distribute, apportion, or allocate gross

income or deductions,” rather than to consolidate accounts.

Most importantly, however, that power was made totally

discretionary in the Commissioner—the taxpayer’s right under

the 1924 Act to cause the statute to be invoked was eliminated.

Section 45 remained in the above form, with only minor

changes, until its re-enactment as Section 482 of the Internal

Revenue Code of 1954. The text of Section 482 has since only

been technically revised.

Thus, as is evidenced not only by the present language of

Section 482, but by the development of that language, a

taxpayer has no right or obligation to make, or cause to be

made, adjustments under Section 482. A taxpayer’s only

obligation is to report its gross income and deductions in a

manner which accurately reflects its business transactions as

ee eS eee

they exist. The sole right to make a section 482 adjustment

which would conform, for tax purposes, the actual facts and

circumstances to what the Government feels might have been

the form had the parties not been related, belongs to the

Government, and that right is one to be exercised in its

discretion. As provided in the Regulations promulgated under

Section 482:

Section 482 grants no right to a controlled taxpayer to

apply its provisions at will, nor does it grant any right to

compel the district director to apply such provisions.

Treas. Reg. § 1.482-1(b)(3) (1968).

Interstate Fire Insurance Co. v. United States, 215 F.

Supp. 586 (E.D. Tenn. 1963), aff'd, 339 F.2d 603 (6th Cir.

1964), demonstrates how the above principles are applied. In

that case, taxpayer was advised, on audit, that a reallocation of

expenses on a cost basis pursuant to Section 482 would. be

made. As a result, taxpayer developed a cost accounting

system, in consultation with the IRS agent, as a basis for

reallocation. The cost accounting method formulated was

found to be sound and correct. Having devised the system.

taxpayer filed amended returns. The primary theory of tax-

payer was that since the agent invoked his discretion under

Section 482, taxpayer was entitled to use of the method. For

pertinent purposes, the issue was whether or not Section 482

had been invoked. In assessing the question, the court stated:

Section 482 provides that the Secretary of the Treasury or

his delegate “‘may” reallocate the expenses, etc., of a

controlled taxpayer “if he determines that such dis-

tribution, apportionment, or allocation is necessary in

order to prevent evasion of taxes or clearly to reflect

income.” The above quoted language makes two things

apparent. In the first place, use of Section 482 is dis-

cretionary with the Secretary or his delegate. Both the

legislative history and the treasury regulations issued con-

firm this. In the second place, use of Section 482 requires a

determination by the Secretary or his delegate that a

reallocation is necessary to avoid tax evasion or to clearly

reflect the income. National Securities Corp. v. Commis-

sioner, 3 Cir., 137 F. 2d 600.

In view of the discretion invested in the Secretary or his

delegate it is likewise apparent that Section 482 can only

be invoked by the government and its use is nota Matter of

right with the taxpayer. To contend otherwise would be to

extend rights and privileges under Section 482 to a con-

trolled taxpayer not enjoyed by other taxpayers, an ob-

viously untenable result.

215 F. Supp. at 597, 598.

The Court'then concluded that “as a general rule the use

and application of Section 482 does not result in an enforceable

tax consequence until there has been a reallocation resulting in

a reassessment of taxes.” 215 F. Supp. at 598. The Court

further stated that cases of abuse of discretion or estoppel were

not subject to the general rule, and, accordingly, held that since

taxpayer went to substantial expense in formulating the system

with respect to its 1955 tax year, the cost accounting method

would be applied for that year only.

Thus, a tax liability can arise pursuant to a Section 482

adjustment only if, and when, governmental discretion has

been exercised and has resulted in an assessment of the tax,

and, as in the accumulated earnings context, interest can

commence only at that time. The integral language of Motor

Fuel Carriers quoted and of Loper Lumber quoted in Part B

supra is of equal applicability to a Section 482 tax liability.

Thus, under Section 482, the taxpayer has no duty or right

to report. There is no liability, whatever the underlying facts

and circumstances, absent the exercise of governmental dis-

cretion, and the culmination of that action in an enforceable tax

consequence. The myriad of factors which may influence the

exercise—or non-exercise—of discretion in any particular case,

while not discussed above, only compounds the difficulties. The

SO Ai anes

foregoing are not merely common sense observations, but, as

demonstrated above, clear legal conclusions mandated by the

statutory pattern, the Government’s own regulations, and the

case law.

The Decision Below Fails To Address Well Established

Doctrine

Outlined above is a very basic proposition which is evident,

not only by virtue of the statutory interest provisions, but the

case law, that a taxpayer cannot, and should not, be expected to

pay interest on tax from the tax return due date if the taxpayer

was legally prohibited from reporting that tax on the return.

The Court of Claims failed to address this basic principle, and,

as such, that opinion is seriously deficient.

In lieu of focusing upon the issue, the majority Court of

Claims opinion, at considerable length, states that the purpose

of Section 482 is to correct income, while Section 531 can be

described as a penalty. Under the Motor Fuel Carriers

rationale, the significance of this distinction is not apparent, as

Judge Nichols noted in his dissent below. The majority opinion

further finds significant the fact that a Section 482 allocation is

reflected in the tax imposed under Section 11. Since tax

attributable to a Section 482 allocation is not reportable on a

return, however, we fail to see the significance of this fact for

interest computation purposes, nor, again, did Judge Nichols.

In fact, the statutory interest provisions read quite to the

contrary. Thus, Section 6601(a) provides that:

If any amount of tax imposed by this title ... is not

paid on or before the last date prescribed for payment,

interest on such amount ... shall be paid for the period

from such last date to the date paid.

I.R.C. §6601(a) (emphasis added). Whether discussing Sec-

tion 531 or Section 11, the issue is whether “any amount” is not

paid on or before the “last date prescribed for payment,” in

which case interest runs on “such amount.” In determining the

last date prescribed for payment, Section 6151(a), entitled

“Time And Place For Paying Tax Shown On Returns,” reads

pertinently as follows:

[When a return of tax is required under this title or

regulations, the person required to make such reiurn shall,

without assessment or notice and demand from the Secre-

tary, pay such tax to the internal revenue officer with whom

the return is filed, and shall pay such tax at the time and

place fixed for filing the return.

I.R.C. §6151(a). (emphasis added) Since a return of tax

resulting from a Section 482 allocation is not permitted, “such

tax” cannot be paid at the time and place fixed for filing the

return. It follows that the return due date is nor the last date

prescribed for payment. We would add that if Petitioner’s

plain reading of the above statute is not accepted, the continued

validity of Motor Fuel Carriers would be in question, since the

Court of Claims has itself at least suggested that the annual

income tax return is a return to which the accumulated earnings

tax relates, even though that tax cannot be shown thereon. See

J.O. Johnson, Inc. v. United States, 73-1 U.S. Tax Cas. J 9352

(Ct. Cl 1973).

The need for the exercise of the supervisory power of this

Court is manifested by the thoughtful dissenting opinion of

Judge Nichols below. Judge Nichols did not view either of the

grounds cited by the majority opinion and discussed above as

dispositive. Rather, Judge Nichols viewed the pragmatic need

for administrative determination in order to determine the

liability as critical. Hence, Judge Nichols would have differ-

entiated among the years, finding in favor of taxpayer for the

years prior to the 1968 adoption of the Section 482 regulations

and for the Government for the later years, the theory being

that after adoption, more specific guidance was available. The

views of Judge Nichols are further evidence of the fact that this

important issue was not fully addressed below, and is deserving

of this Court’s attention.

We agree with Judge Nichols that the Court in Motor Fuel

Carriers may well have been heavily influenced by the practical

difficulties faced by a taxpayer who has no right or obligation to

report tax. However, it is the lack of a right to report, rather

than the difficulty in projecting liability, which was dispositive

under Motor Fuel Carriers. While, admittedly, a taxpayer’s

ability to project the discretionary action which might be taken

on an interest-free loan was heightened by the Regulations, a

taxpayer still could not project that liability with certainty. See

Treas. Reg. § 1.482-2(a)(1). Furthermore, the Regulations

governing other Section 482 adjustments give taxpayers little

certainty. See, for example, Treas. Reg. § 1.482-2(e). From

the opposite perspective, in certain situations, a taxpayer can

project its accumulated earnings tax liability with a high degree

of certainty (if, of course, it is to be assumed that the

Government will exercise its discretion and charge an accumu-

lated earnings tax liability), but the Motor Fuel Carriers

opinion is not limited to the difficult situation.2 We would

submit, accordingly, that the Court of Claims in Motor Fuel

Carriers recognized, as a general rule, the practical difficulties

imposed upon a taxpayer in projecting liabilities which would

not exist unless the government exercised its discretion to make

them exist. That recognition no doubt lead to its decision that if

a liability will arise only if the Government decides to make it

arise, interest runs from the date of notice and demand for

payment of the tax, and not from the return due date.

8 One such example is the case of a mere holding or investment

company. Such fact would be prima facie evidence of purpose to

avoid federal income tax with respect to shareholders, and the amount

of the liability would be a mere matter of computation. Section 533

(b); 535 (c) (3).

CONCLUSION

The Court of Claims, in an en banc decision in 1970, took

an innovative and thoughtful approach to a very difficult and

important issue in Motor Fuel Carriers. That action, despite

authority to the contrary then existing, was uniformly followed

in subsequent case law. The issue presented here, one of first

impression and of major significance, squarely addresses the

true rationale of Motor Fuel Carriers in an important context,

and the issue will no doubt arise again, in this context and in

others. The implications, furthermore, are serious. The

uncertainty and conflict with respect to this difficult and impor-

tant issue should be resolved now, and, accordingly, we respect-

fully request that a writ of certiorari issue.

Respectfully submitted,

Morgan J. Ordman

110 North North Wacker Drive

Chicago, Illinois 60606

(312) 346-6191

Attorney for Petitioner,

Morton-Norwich Products, Inc.

Of Counsel:

Frank R. Krok

Paul G. Simon

McBride, Baker, Wienke & Schlosser

110 North Wacker Drive

Chicago, Illinois 60606

(312) 346-6191

December, 1979

APPENDIX

APPENDIX A

Hu the Gaited States Court of Claims

No. 83-77

(Decided July 18, 1979)

MORTON-NORWICH PRODUCTS, INC., A

CORPORATION v. THE UNITED STATES

Frank A. Wollaeger, attorney of record, for plaintiff.

Morgan J. Ordman, Frank R. Krok, McBride, Baker,

Wienke & Schlosser, of counsel.

D. Patrick Mullarkey, with whom was Assistant Attorney

General M. Carr Ferguson, for defendant. Theodore D.

Peyser, of counsel.

Before NicHoLs, KuNzIG, and BENNETT, Judges.

ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND

DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

BENNETT, Judge, delivered the opinion of the court:

Plaintiff, Morton-Norwich Products, Inc., seeks refunds

for overpayments of federal income taxes and interest for

tax years 1965 through 1973. The case, which presents

various claims for refund, is before the court on cross-

motions for summary judgment.

In Counts II and VI of the petition, taxpayer claims

refunds for a loss deductible under I.R.C. § 165(a). This loss

involved research and development expenditures (R&D)

incurred in an attempt to discover uses and methods of

recovery of geothermal deposits (plaintiff having had a

substantial leasehold interest in a geothermal deposit),

which R&D costs plaintiff had elected to capitalize pursu-

ant to I.R.C. § 174, and claimed to have been abandoned in

1970 (Count II) or, in the alternative, 1973 (Count VI).

Counts IV (for the tax year ending June 30, 1971) and V

(for the years ending June 30, 1972, and June 30, 1973)

examine whether, if plaintiff prevails on Count II, it may,

under section 162(a), deduct certain expenses subsequently

incurred as ordinary and necessary business expenses

related to the underlying leasehold plaintiff retained. Per

stipulation, the parties agreed that the bad debt claim

stated in Count III was erroneous and properly disallowed.

The amount of such losses ($38,108) is added, by stipula-

tion, to plaintiffs deferred R&D costs, and thus to

plaintiff's claim for an abandonment loss under Count II or

V1.

We determine that the issues involved in these counts

cannot be decided on summary judgment as, despite the

existence of stipulations and agreements as to some of the

facts, there are still issues of fact to be resolved. Therefore,

we remand that portion of the petition to the trial division.

The issue posed for resolution in Count I of the petition is

whether interest on a deficit in income tax for the taxable

years at issue resulting from the allocation, pursuant to

I.R.C. § 482, of gross income and deductions between

plaintiff and its affiliated corporation on account of non-

arm’s-length, interest-free loans is properly calculated from

the time the original income tax returns for those years

were due, or from the time that notice and demand for

payment were made. This presents an important issue of

first impression which is appropriate for summary judg-

ment. For the following reasons, we hold that interest on

' LR.C. § 482 provides:

“In any case of two or more organizations, 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 distribute, apportion, or allocate gross income. deductions, credits, or

allowances between or among such organizations, trades, or businesses, if he

determines that such distribution, apportionment, or allocation is necessary in order

to prevent evasion of taxes or clearly to reflect the income of any of such

organizations, trades, or businesses.”

income tax resulting from a section 482 allocation is

properly assessable from the time the original return was

due and grant judgment accordingly for defendant.

Morton-Norwich is the parent of an affiliated group of

corporations. During the years 1965 through 1973 it made

loans to its wholly owned foreign subsidiaries. No interest

was charged on these loans. During those periods taxpayer

had borrowed funds from third parties and claimed

deductions for interest paid on those funds. The Commis-

sioner determined that taxpayer had underpaid its tax for

those years to the extent it had not reported interest at the

rate of 5 percent on the loans it tendered.? Correlative

adjustments were made with respect to the taxes of the

subsidiaries which had received the loans.®

The taxpayer originally filed a petition in the Tax Court

challenging the IRS’s determination of liability for some of

the years involved. A settlement was reached and em-

bodied in a stipulation in the Tax Court. Also, the taxpayer

and Commissioner agreed upon the amount of adjustment

for the years after the Tax Court action. Neither the

agreement nor the stipulation waived taxpayer’s right to

file claims for refund or credit based on the contention that

some or all of the interest on the deficiencies was not

properly due the IRS. Taxpayer paid the assessments

agreed upon, plus interest from the date that the tax

returns for the involved periods were due to the date of

payment. Plaintiff seeks a refund of the amount of interest

charged from the date that the original tax was due to the

date of the Service’s notice and demand for payment of the

deficiency.

The general rule for interest is that it runs from the

‘last date prescribed for payment,” to the date paid. I.R.C.

2 In 1968, the Secretary of the Treasury promulgated regulations specifying that,

retroactive to tax years beginning after 1953, interest would be imputed on loans at

the rate of 5 percent simple interest if no interest had been charged. See Treas. Reg.

§ 1.482-2an2nii) (1968).

' Treas. Reg. § 1.482-1\dx2) (1968) provides that where income or deductions are

allocated to one member of a controlled group, correlative adjustments are made to

the income or deductions of the other affected member

§ 660l(a). When a return of tax is required, section 6151,

entitled ‘Time and place for paying tax shown on returns,”

requires a taxpayer to pay the tax at the time and place

fixed for filing the return. If the date for payment is not

prescribed, the last date for payment is deemed to be the

date the liability arises, in no event later than notice and

demand therefor. I.R.C. § 6601(b\4). One exception to the

general rule is that interest only runs on an assessable

penalty, additional amount, or addition to the tax from the

date of notice and demand. I.R.C. § 6601(e\3).

Our problem is how to treat within this framework the

underpayment of income tax for a taxable year resulting

from a section 482 allocation. Plaintiff's argument that the

general rule does not apply depends upon the application

to this case of the doctrine enunciated with respect to the

accumulated earnings tax, I.R.C. § 531,4 set forth in the

opinion of this court in Motor Fuel Carriers, Inc. v. United

States, 190 Ct. Cl. 385, 420 F.2d 702 (1970).

In Motor Fuel Carriers, this court held that interest did

not begin to run on the assessment of the accumulated

earnings tax until notice and demand were made. The

court supported its conclusion on alternative grounds: (1)

the accumulated earnings tax was an “assessable penalty,

additional amount, or addition to the tax” within the

meaning of section 6601(f3) [now I.R.C. § 6601(eX3));5 and

(2) if the general rule of section 6601(a) did apply, the last

date prescribed for payment was the date of notice and

demand pursuant to section 6155. Other courts have

reached the same results with respect to the accumulated

earnings tax. Bardahl Mfg. Corp. v. United States, 452 F.2d

604 (9th Cir. 1971) (section 531 tax an addition to the tax or

+ 1RC. § 531 provides

"In addition to other taxes imposed by this chapter. there is hereby imposed for

each taxable vear on the accumulated taxable income ‘as defined in section 535) of

every corporation described in section 532. an accumulated earnings tax equal to the

sum of—

(1) 27, percent of the accumulated taxable income not in excess of $100,000.

plus

(2) 38, percent of the accumulated taxable income in excess of $100,000."

* Subsections ‘c) and (f) of section 6601, applicable to the tax vears in dispute, were

redesignated as subsections (b) and ‘e), respectively, by section 7ibk1) of the Act of

January 3, 1975, Pub. L. No. 93-625, 88 Stat. 2108. For convenience, we will use the

current designations of this section.

- —

“a Pate ees

penalty (§ 6601(eX3))); Ray E. Loper Lumber Co. v. United

States, 444 F.2d 301 (6th Cir. 1971) (last date for payment of

accumulated earnings tax not prescribed (§ 6601(b\4))).

The court in Motor Fuel Carriers relied on the following

principal factors in determining that either the accumu-

lated earnings tax was an addition to the tax under section

6601(eX3) or that the last date prescribed for payment was

the date of notice and demand under sections 6155 and

6601(a). The first was that it was clear from the statute, the

legislative history, and administrative practice that the

accumulated earnings tax was separate from, and in

addition to, the normal corporate income tax under section

11. The statute explicitly provides that such tax is “{i]n

addition to other taxes imposed by this chapter.” I.R.C. §

531. Second, the tax was not self-assessable like normal

income taxes, but assessment requires ‘‘an administrative

determination by the Service” of the fact and amount of

the unreasonable accumulation of earnings and profits.

Motor Fuel Carriers, Inc. v. United States, supra, 190 Ct. Cl.

at 393, 420 F.2d at 707. “There is no provision in, or part of,

Treasury Form 1120 (the return form) for reporting the

amount subject to this tax; nor are there any schedules or

instructions for reporting the item. It is left wholly to the

Government’s initiative.” Id. at 390, 420 F.2d at 705 [cite

omitted]. In the court’s thinking, it was the second group of

factors which demonstrated the logic of treating the

liability for the accumulated earnings tax as not having

vested until notice and demand. The logic has supported

the result in respect to the accumulated earnings

tax—whether the rationale was that it is a penalty or

addition to the tax under Motor Fuel Carriers or Bardahl,

or that the last date prescribed for payment was the date of

notice and demand under Motor Fuel Carriers, or that the

last date for payment was not prescribed under Loper.

Other than certain superficial similarities concerning

assessments under sections 531 and 482, the provisions are

not at all comparable. Section 531 imposes a tax after the

normal corporate income tax is assessed under section 11,

on the unreasonable accumulation of earnings and profits

of a corporation. The tax is imposed on a corporation

eee tne

“formed or availed of for the purpose of avoiding the income

tax with respect to its shareholders * * *.” I.R.C. § 532(a).

Special rates, unrelated to corporate income tax rates, are

applied not to taxable income, but to that portion of after-

tax income which has been unreasonably accumulated.

Section 482, however, does not impose a tax by operation

of its provision alone. The section authorizes the Secretary

to “distribute, apportion, or allocate gross income,. deduc-

tions, credits, or allowances between or among [corpora-

tions].” I.R.C. § 482. Such action can change the amount of

taxable income of a corporation for a taxable year resulting

in the recomputation of the corporate income tax under

section 11. The Secretary’s action results in the amend-

ment of the original corporate income tax return to show

the proper amount of gross income, deductions, credits, or

allowances. It is under the provisions of section 11, which

provide for a tax on the taxable income of corporations,

that an overpayment or underpayment of the proper tax is

found.

Section 531 has often been described as a penalty

imposed upon corporations for their failure to distribute

dividends to their shareholders. See Motor Fuel Carriers,

Inc. v. United States, supra, 190 Ct. Cl. at 391 n.6, 420 F.2d

at 706 n.6. In keeping with the characterization of section

531 as a penalty, the burden of proof in a_ judicial

proceeding is often on the Government. I.R.C. § 534(a).

Whatever the proper characterization of the accumufated

earnings tax, an allocation under section 482 is not a

penalty, or addition to the tax, but, as pointed out by

defendant, an income-correction device. The burden of

proof is squarely on the taxpayer to show that the Service

acted in an arbitrary manner. See, e.g., Young & Rubicam,

Inc. v. United States, 187 Ct. Cl. 635, 410 F.2d 1233 (1969).

Correction is effected by nonpenal, correlative adjustments

in the respective corporation’s taxable income. Treas. Reg.

§ 1.482-1(d\(2) (1968).6 Also, consideration is taken of other

non-arm’s-length transactions between the corporations “in

* In the case of interest-free loans. imputation of interest income to the lender

corporation results in imputation of an interest deduction to the borrower

corporation.

the taxable year which, if taken into account, would result

in a set off against any allocation which would otherwise be

made * * *.” Treas. Reg. § 1.482-1(d3) (1968). Indeed, the

Service once had difficulty in asserting its power in the

specific ares of the imputation of interest on loans where

the result worked as a penalty because of the absence of

correlative adjustments. See Tennessee-Arkansas Gravel Co.

v. Commissioner, 112 F.2d 508 (6th Cir. 1940); Smith-

Bridgman & Co. v. Commissioner, 16 T.C. 287 (1951); Rev.

Rul. 67-79, 1967-1 C.B. 117.7

Under section 482, the Secretary is only authorized to

take action “in order to prevent evasion of taxes or clearly

to reflect the income of any [corporation].” The Secretary’s

authority is geared to the determination of the true taxable

income of a controlled taxpayer which is the taxable

income which would have resulted to the controlled

taxpayer had it in the conduct of its affairs dealt with the

other member or members of the group at arm’s length. As

this court (and others) has often noted, the thrust of this

section is to put controlled taxpayers on a parity with

uncontrolled taxpayers. See, e.g., Young & Rubicam, Inc. v.

United States, supra; Eli Lilly & Co. v. United States, 178

Ct. Cl. 666, 372 F.2d 990 (1967). Inherent in this section is

the rationale that if transactions between related parties

were structured on an arm’s-length basis in accordance

with economic reality, the proper corporate taxable income

and tax would be returned and paid. The Government

would have had the use of the revenue from the time the

original return was due. If interest did not run from the

time the original return was due, controlled taxpayers

whose gross income and deductions were distorted due to

the artificial, controlled transactions, would never be on a

parity with uncontrolled taxpayers whose transactions

would be structured on an arm’s-length basis. The failure

to impose interest until the taxpayer was caught by the

Service would be a definite benefit to be gained by

? The Tax Court in Smith-Bridgman & Co. v. Commissioner, supra, 16 T.C. at 294,

stated:

"That the respondent did not ‘allocate’ gross income of Continental to petitioner

is apparent, since the record shows that he made no adjustment to the income or

deductions of Continental.”

distorting income in the controlled situation. In enacting

section 482, Congress certainly did not intend that there be

an incentive for income tax distortion or evasion.

Section 482 has its roots in section 240(d) of the Revenue

Act of 1921 (section 240(f) of the 1926 Act) where the

Commissioner was given the power to consolidate accounts

of related trades or businesses for purposes of making the

correct distribution of gains, profits, income, deductions, or

capital in order to prevent the arbitrary shifting of profits.

S. Rep. No. 275, 67th Cong., Ist Sess. 20 (1921). The

provision as it appears today was first enacted in section 45

of the Revenue Act of 1928 to fill in the gap or substitute

for the consolidated return provisions.’ Under the consoli-

dated return provisions of the 1926 Act, and the power

granted to the Commissioner to consolidate accounts under

section 240(f), the resultant tax liability was reported on

the original return filed in accordance with section 241.

Though the mechanics of sections 240(f) and 45 were

different, their objective was the same, to ensure that

affiliated businesses paid the proper tax.

Though plaintiff does not dispute the fact that the nature

and purpose of sections 531 and 482 are quite different,

plaintiff contends that the mode of their determination and

mechanics of their assessment are the same, and, therefore,

the same rule should govern the imposition of interest.

Like the section 531 tax, plaintiff argues, there is no place

on the income tax return to report the tax due resulting

from a section 482 allocation, and the tax imposed on

account of a section 482 allocation results from an

administrative determination rather than the initiative of

the taxpayer. Plaintiff cites Treas. Reg. § 1.482-1(b\3)

(1968) which provides that section 482 is not available to a

taxpayer nor may a taxpayer force the Service to exercise

its discretion. See also Interstate Fire Ins. Co. v. United

States, 215 F. Supp. 586 (E.D. Tenn. 1963), aff'd, 339 F.2d

* Section 45's purpose was described as follows:

“Section 45 is based upon section 240f) of the 1926 Act, broadened considerably

in order to afford adequate protection to the Government made necessary by the

elimination of the consolidated return provisions of the 1926 Act.” [H.R. Rep. No.

2, 70th Cong.. Ist Sess. 16-17 (1928): S. Rep. No. 960, 70th Cong.. Ist Sess. 24

(1928).]

603 (6th Cir. 1964). Thus, plaintiff argues, once it has

chosen a particular way of dealing with its affiliates, the

form is controlling of income tax consequences unless the

Secretary exercises his discretionary power.

The inability of a taxpayer to report income on the basis

of the substance of its transactions with an affiliate rather

than the form of its transactions when the substance would

result in tax savings is quite different from a taxpayer’s

ability or inability to report accumulated earnings tax. No

taxpayer could ever possibly wish to avail itself of the

privilege of paying accumulated earnings tax. A taxpayer

might very well wish to use section 482 when through

inadvertence or design it has treated an affiliate in a non-

arm’s-length manner which has resulted in increased tax

liability. Under section 531, if the corporation properly

distributes earnings and profits, the corporation has no

liability for tax. On the other hand, if controlled entities

properly structure their transactions on an arm’s-length

basis, the proper amount of tax is due and owing. Power is

granted to the Secretary to achieve this result. The

inability of a taxpayer to restructure the form of its

transactions for tax purposes though the IRS may very well

be permitted to do such has long been a part of our tax law

and cannot be the determinative factor here. As the

Supreme Court has stated:

* * * This Court has observed repeatedly that, while a

taxpayer is free to organize his affairs as he chooses,

nevertheless, once having done so, he must accept the

tax consequences of his choice, whether contemplated or

not [cites omitted], and may not enjoy the benefit of some

other route he might have chosen to follow but did not.

[Commissioner v. National Alfalfa Dehydrating & Mill-

ing Co., 417 U.S. 134, 149 (1974).]

On the other hand:

* * * the Government may not be required to acqui-

esce in the taxpayer’s election of that form for doing

business which is most advantageous to him. The

Government may look at actualities and upon determina-

tion that the form employed for doing business or

carrying out the challenged tax event is unreal or a

sham may sustain or disregard the effect of the fiction as

best serves the purposes of the tax statute. To hold

10a

otherwise would permit the schemes of taxpayers to

supersede gislation in the determination of the time

and manner of taxation. [Higgins v. Smith, 308 U.S. 473,

477-78 (1940) (emphasis added).]

Section 482 is simply one statutory component of the

Government’s arsenal, like I.R.C. § 446(b) (power to change

taxpayer’s accounting method in order to clearly reflect

income), or the judicial doctrines of assignment of income

and tax benefit (which are, indeed, concepts included

within section 482’s ambit) to ensure that the correct

amount of income and tax is reported and paid.

Further, we disagree with the view that a tax resulting

from a section 482 allocation, like the accumulated

earnings tax, is not a tax to be paid by return. Unlike the

accumulated earnings tax, where there is no indication in

the statutes, regulations, or income tax forms that a return

of such tax is required, the tax resulting from a section 482

allocation is imposed by section 11 on the basis of a

required return, Treas. Reg. § 1.11-1(a) (1960).9 Treasury

Form 1120 prescribed by Treas. Reg. § 1.6012-2(aX3) (1968)

has places for and requires the proper reporting of gross

income, deductions, credits, and allowances. Though the

Government may have no liability because of an overpay-

ment caused by non-arm’s-length dealing due to congres-

sional design, the taxpayer does have a liability for an

underpayment which liability accrues or vests when the

return is due even though the taxpayer may not know the

exact amount of that liability. Cf. United States v.

Northwestern Mutual Ins. Co., 315 F.2d 723 (9th Cir. 1963).

From 1968 on, however, this taxpayer would have been

aware of its exact liability on account of Treas. Reg. §

1.482-2(a) (1968) which sets explicit rules for interest-free

loans. Therefore, we conclude that a liability resulting

from a section 482 allocation is simply part of the general

liability imposed by section 11 which requires a return.

Thus, interest on a deficiency is computed in accordance

with sections 615l(a) and 6601(a).

* “The tax imposed by section 11 is payable upon the basis of returns rendered by

the corporations liable thereto, except that in some cases a tax is to be paid at the

source of the income.” Treas. Reg. § 1.11-lta) (1960).

lla

CONCLUSION

We therefore determine that interest properly runs on

an income tax deficiency resulting from an allocation

under I.R.C. § 482 from the time the original return was

due. Defendant’s cross-motion for summary judgment is

granted as to Count I of the petition and plaintiff's motion

is denied. Count I of the petition is dismissed.

As to Counts II through VI, summary judgment is denied

both parties and the case is remanded to the trial division

for further proceedings.

NICHOLS, Judge, concurring in part and dissenting in

part:

I agree with the court’s result as to the claim under

Count I for refund for interest paid on deficiencies for tax

years 1968-73, but respectfully differ as to tax years

1965-67. I agree with the disposition of Counts II—VI and

do not discuss them further. I do not join in the opinion

except in that small part. The following relates only to

Count I.

I view the approach of the majority as simplistic in its

treating all tax years alike despite the decisive change in

the applicable law enacted in 1968 by the regulations

implementing the grant of authority in I.R.C. of 1954, §

482. The majority assumes sub silentio that before 1968

any layman would have known whether or not the

Commissioner would make a § 482 reallocation, that the

layman could or should have structured his affairs to

anticipate what the Commissioner would subsequently hold

was necessary to prevent evasion or clearly to reflect

income, and that the layman was somewhat of a tax evader

if his crystal ball failed him and the Commissioner made a

reallocation he had not foreseen. Aiternatively, the panel

supposes that one in charge of a controlled group knows

exactly the monetary differences between whatever inter-

company transactions he engineers and what they would

have been if conducted at arm’s-length by independent

entities.

It is obvious that in 1962 the Congress called for

regulations because it perceived the situation entirely

12a

differently, and wanted reallocations to rest on rules that

taxpayers could know. The Treasury agonized six years at

the appallingly difficult task of producing such regulations,

then setting forth what was, according to our majority

here, obvious.

With all respect, it appears to me the majority opinion in

American Standard, Inc. v. United States, No. 379-76 (Ct.

Cl. June 13, 1979) reflects the same dangerous delusion as

to the obviousness (to the eye of superrational intuition,

perhaps) of intricate accounting adjustments, so that tiie

uneducated and uninstructed intellect can decide at a

glance what adjustments are necessary, e.g., to reflect

taxable income. I show in more detail further on how

unobvious it really was. Even a trained eye would not have

seen an adjustment as an. automatic or required conse-

quence of the given facts. It was really and truly

discretionary.

Assuming then that before 1968 the likelihood of an

adjustment would depend to the ordinary mind on the

exercise of uncontrolled discretion on unpublished grounds,

by subordinate Treasury officials, the case seems to me to

fall for 1965-67 well within the rule of Motor Fuel Carriers,

Inc. v. United States, 190 Ct. Cl. 385, 420 F.2d 702 (1970).

The heart of that case seems to be that the liability for

interest back to the date the return is due would not

include interest on a deficiency resulting from, not the

facts set forth or required to be set forth in the return, or in

later amendments thereto, but from the subsequent exer-

cise of broad discretion by an administrative official.

What follows was first prepared in hope of its being

accepted as a majority opinion and explains how I would

treat 1965-67 and also how and why I would differentiate

1968 and later years.

The taxpayer is the parent of an affiliated group of

corporations. During the years 1965 through 1973, it made

loans to its wholly owned subsidiaries. No interest was

charged on these loans. During those periods, taxpayer had

borrowed funds from third parties and claimed deductions

for interest paid on those funds. The Commissioner .

determined that taxpayer had underpaid its tax for those

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years to the extent it had not reported interest at the rate

of 5 percent on the loans it tendered. Correlative adjust-

ments were made with respect to the taxes of the

subsidiaries.

The taxpayer originally filed a petition in the Tax Court

challenging the IRS’s determination of liability for some of

the years involved. A settlement was reached and em-

bodied in a stipulation in the Tax Court. Also, the taxpayer

and Commissioner agreed upon the amount of adjustment

for the years after the Tax Court action. Neither the

agreement nor the stipulation waived taxpayer’s right to

file claims for refund or credit based on the contention that

some or all of the interest on the deficiencies was not

properly due the IRS. Taxpayer paid the assessments

agreed upon, plus interest from the date that the tax

returns for the involved periods were due to the date of

payment.

Taxpayer says it is entitled to a refund of the amount

paid in interest from the date that the tax returns for the

involved periods were due to the date that notice and

demand for payment was made following the assessments.

Appendix A lists the tax periods involved in this case and

the alleged overpayments of interest claimed by the

taxpayer.

The Internal Revenue Code requires that interest be paid

on taxes due from “the last date prescribed for payment” of

the tax until the date paid. 26 U.S.C. § 6601(a). Section

6151, entitled ‘Time and Place for Paying Tax Shown on

Returns,” orders a taxpayer who files a required return to

pay the tax at the time and place fixed for filing the return.

26 U.S.C. § 6151. This statute applies when a taxpayer does

not need an assessment or notice and demand from the

Secretary. When notice and demand is issued, the tax is to

be paid at the time stated in the notice. 26 U.S.C. § 6155(a).

If the date for payment is not prescribed, that date is

deemed to be the date the liability for payment arises, and

in no event is later than the date of the Commissioner’s

notice and demand. 26 U.S.C. § 6601(bX4). An exception to

14a

these general rules is set forth in 26 U.S.C. § 6601(eX3),

which provides that:

Interest shall be imposed under subsection (a) in

respect of any assessable penalty, additional amount, or

addition to the tax only if such assessable penalty,

additional amount, or addition to the tax is not paid

within 10 days from the date of notice and demand

therefor, and in such case interest shall be imposed only

for the period from the date of the notice and demand to

the date of payment.

Plaintiffs argument relies heavily on our decision in

Motor Fuel Carriers, Inc. v. United States, 190 Ct. Cl. 385,

420 F.2d 702 (1970). In that case, taxpayer was assessed

deficiencies which included liabilities under 26 U.S.C. § 531

(the accumulated earnings tax). The IRS assessed interest

from the due date of taxpayer’s return. The government

had successfully asserted liability. On the suit for refund of

the interest assessed, this court ruled for taxpayer,

concluding that interest began to run on the date of notice

and demand. The court’s decision was based on alternative

grounds: (1) the accumulated earnings tax was an “assessa-

ble penalty, additional amount, or addition to the tax”

within the meaning of § 6601(fX3) [the present § 6601(e\3));

and (2) if the general rule of § 6601(a) applied, the last date

prescribed for payment was the date of notice and demand

pursuant to § 6155.

Plaintiff states that the theory on which these alterna-

tive grounds lie applies to the present case. The rationale

for both alternatives in Motor Fuel Carriers, Inc., supra,

plaintiff argues, was that there was a need for an

administrative determination before taxpayer owed any

accumulated earnings tax. The court stated:

* * * It is inherent in the nature of the tax—and was

formerly recognized specifically by Congress—that a

taxpayer can hardly determine for itself, with any

accuracy, if the tax is due, and if so to what extent. * * *

[190 Ct. Cl. at 390, 420 F.2d at 705.)

The same focus on the need for an administrative

determination of tax liability influenced the decision of

other courts in cases following Motor Fuel Carriers, see, e.g..

Bardahl Mfg. Co. v. United States, 452 F.2d 605 (9th Cir.

15a

1971); Loper Lumber Co. v. United States, 444 F.2d 301 (6th

Cir. 1971). Both cases ruled that interest was not due on

the accumulated earnings tax until date of notice and

demand. Bardahl explicitly adopted the reasoning of Motor

Fuel Carriers in support of its conclusion that § 6601(f\3)

controlled; Loper did not rule on the applicability of that

statute. Rather, the Sixth Circuit reached the same result

as Motor Fuel Carriers, but did so by holding that §

6601(c\4) [redesignated § 6601(b\4) in 1975] controlled

rather than §§ 660l(a) and 6155.

The present arguments and indeed the analysis in Motor

Fuel Carriers and subsequent cases focus on whether the

taxpayer could self-assess and report its tax liability as

determined at the time it filed its returns. Plaintiff argues

that § 482 is a discretionary tool of the IRS, that the IRS

may or may not use it as it sees fit, and that at the time of

filing its return Morton-Norwich could not possibly have

accommodated for a possibility that the IRS would declare

it liable for additional tax, nor estimate the amount of tax.

Given then that affirmative IRS action was necessary for

the IRS to generate income tax liability, there is no

authority to assess interest back to the date the return is

due. Taxpaver can argue either (a) the tax is a “penalty,

additional amount, or addition to the tax” under §

6601ie%3); (b) under § 6601l(a) the last date prescribed for

payment is the date of notice and demand pursuant to §

6155; or (c) as no tax is due on the date the return is filed,

under § 6601(b\4), the last date for payment is not

prescribed, so tax liability does not incur until there is

notice and demand for the tax. The first two arguments

have their basis in Motor Fuel Carriers; the last in Loper.

The government, however, discounts the applicability of

Motor Fuel Carriers and its progeny with two arguments,

both based on the fact that those cases dealt with the

accumulated earnings tax and this case concerns a

deficiency assessed under §482. First, it emphasizes that §

482 is not a penalty but an income-correction device. It

contrasts § 482 with the accumulated earnings tax, which

l6a

has traditionally been considered as and often been

described as a “penalty.” See Note, The Accumulated

Earnings Tax—Sections 531-37 of the 1954 Code, 64 Nw.

Univ. L. Rev. 239, 240 (1969). The accumulated earnings

tax is not directly related to the quantum of a taxpayer’s

income. Once a determination of accumulated taxable

income as defined in § 535 is made by the IRS according to

the procedures specified in §§ 532-34, a tax equal to the

sum of 27!; percent of the accumulated taxable income not

in excess of $100,000, plus 38% percent of the accumulated

taxable income greater than $100,000 is levied. Such a levy

is an “additional amount,” not a percentage of taxpayer’s

income, and liability arises under a different law than the

ordinary income tax liability, which remains unaffected.

Defendant’s second argument is related to the first, but

goes beyond it. The reallocation of income under § 482 does

not really change taxpayer’s income tax liability for the

year in which the adjustment takes place. Rather, it is

designed to ensure that income taxes already due will be

based on a clear reflection of the taxpayer’s own income.

Thus, § 482 adjusts for distortions which existed at the time

the taxpayer’s return was filed, that is, when its tax on

income was due. This is what distinguishes § 482 from the

accumulated earnings tax. Corporate taxpayers have an

obligation to pay their true taxable income, and such true

taxable income is based on arm’s-length dealings with

subsidiaries. This dual requirement is stated in § 11 of the

Code which requires that a corporate taxpayer pay a tax

based on taxable income for the tax year, and § 482 and

Treas. Reg. § 1.482-1(b) [adopted in 1962], which enunciates

an arm’s-length standard for any reallocation of income in

order to determine the correct taxable income for each

taxpayer and each tax year. That § 11 tax on income is due

and reportable on the date on which the return is filed.

Given this statutory scheme, defendant argues that

Morton-Norwich could have anticipated a readjustment of

its reported income under § 482. It was required to

calculate its income as if it had dealt with its subsidiaries

at arm’s-length, as prescribed by the Code and regulations.

Thus, when it acted in a non-arm’s-length manner, it could

17a

anticipate a § 482 reallocation. Defendant seemed to argue

at one time that affiliated corporations had a legal duty to

arrange their internal transactions so as not to distort the

clear reflection of taxable income, and that a § 482

adjustment is made to counteract such a breach of duty.

But it abandoned this extreme position, since a taxpayer

could not make sua sponte a § 482 adjustment in its return

and defendant does not have to do so.

Iil

Defendant is right to this extent: that a taxpayer may

not reap a financial advantage by ignoring a tax statute or

regulation and thus understating its income. If the § 482

reallocation was reasonably certain at the time taxpayer

filed its return, as defendant argues, it is a mere

technicality whether the corporate return form included a

schedule specifying how the taxpayer is to make that

allocation. For if an allocation is necessary to state

properly the corporate taxpayer’s income for a particular

year, and that allocation is inevitable on audit, then the

taxpayer can set aside the money at interest until the IRS

audits and takes the predicted action. To allow controlled

or controlling corporations to engage in non-arm’s-length

transactions which distort their income and then invest the

owed taxes until the IRS’s audit, without a requirement

that interest be imposed on this deferred tax, would ignore

Congress’ intent that controlled companies be treated in

the same manner as uncontrolled companies. See IRS Reg.

§ 1.482-1(b\1); cf. Manning v. Seely Tube & Box Co., 338

U.S. 561 (1950), holding that a taxpayer who has not paid a

deficiency is liable for interest on it even though the

deficiency itself is wiped out by a carryback.

However, until 1968, a taxpayer could not anticipate an

imputed interest reallocation under § 482, as he could then

and after. A taxpayer’s liability for the extension of

interest-free loans to controlled subsidiaries was unclear,

and its tax liability could not be self-assessed under Motor

Fuel Carrier standards. Section 482 provides that:

In any case of two or more organizations, trades or

businesses (whether or not incorporated, whether or not

18a

organized in the United States and whether or not

affiliated) owned or controlled directly or indirectly by

the same interests, the Secretary may distribute, appor-

tion, or allocate gross income, deductions, credits, or

allowances between or among such organizations, trades,

or businesses, if he determines that such distribution,

apportionment, or allocation is necessary in order to

prevent evasion of taxes or clearly to reflect the income

of any of such organizations, trades, or businesses.

Defendant argued that the combination of this statute with

§ 11 of the Code obligates a corporate taxpayer to pay tax

based on his true taxable income calculated by an arm’s-

length standard, and that the IRS audit and reallocation

was foreseeable for each year. It is true that §§ 482 and 11,

and Treas. Reg. § 1.482-1(d) were in effect for the entire

period at issue, but even with these guides, it was not clear

what kinds of loans would distort a taxpayer’s income and

require a reallocation under § 482. This is true even though

the IRS may have been able to assert liability successfully

against some taxpayers for other types of § 482 allocations.

See e.g., Oil Base, Inc. v. Commissioner, 362 F.2d 212 (9th

Cir.), cert. denied, 385 U.S. 298 (1966). As one practitioner,

commenting on the newly enacted (in 1968) regulations

under § 482, stated:

The regulations under section 482, which were pro-

posed in 1966 and adopted in 1968, represent an attempt

to establish quantitative guidelines against which the

statute may be applied. Prior to these regulations, there

were practically no official pronouncements as to the

government's position regarding specific types of transac-

tions under section 482. [Emphasis supplied.] [R. Hoefs,

Intercompany Operations: Joint Use of Employees, Serv-

ices, Plant, Equipment & Intangibles, 26 Nyu INstITUTE

ON FEDERAL TAXATION 603, 606 (1970).]

Indeed, the liability for the extension of interest-free

loans was very unclear. In cases determined under the

predecessor of § 482, § 45 of the 1939 Code, the Tax Court

and others adhered to the doctrine that § 45 only

authorized reallocation of income, and that the Commis-

sioner could not “create” income by inferring a rate of

interest to be charged in order to put controlled corpora-

tions on par with uncontrolled ones. Tennessee-Arkansas

19a

Gravel Co. v. Commissioner, 112 F.2d 508 (6th Cir. 1940),

Smith-Bridgman & Co. v. Commissioner, 16 T.C. 287 (1951).

It was only the adoption of regulations in 1968 that clearly

demonstrated that the IRS would reject this analysis, and

impute interest payments to corporations which made

interest-free loans. Hoefs, supra at 607. Other circuit courts

abandoned the doctrine of “creation of income,” at least as

applied to § 482 imputation of interest charges, fairly

quickly after the regulations, see e.g., B. Forman & Co. v.

Commissioner, 453 F.2d 1144 (2d Cir. 1971), cert. denied,

407 U.S. 934, rehearing denied, 409 U.S. 899 (1972). The

Tax Court abandoned its position only recently in Latham

Park Manor, Inc. v. Commissioner, 69 T.C. 199 (1977).

Until 1968, there were no specific rules to guide

taxpayers like Morton-Norwich. In 1962, Congress rejected

legislation to amend § 482 by specifying powers and

methods of allocation. The conferees thought that the

powers prescribed by § 482 were adequate, but suggested

that regulatory guidelines be drawn. Rev. Act of 1962, H.

Conr. Rep. No. 2508, 87th Cong., 2d Sess. 18-19 (1962)

reprinted in [1962] U.S. Cope Conc. & Ap. News 3732,

3738-39. The suggestion that regulatory guidelines be

drawn tacitly recognizes that guidelines do not exist in the

statute.

Given these inadequate guidelines for reallocation, the

IRS was faced with two choices—it could continue to

exercise its discretion in choosing what parties to subject to

§ 482 and in determining how their income would be

allocated, limited by the requirement that the allocation

put controlled taxpayers on par with uncontrolled tax-

payers, or it could adopt regulations, thus limiting its own

discretion but making its practices and policies under § 482

evident.

The IRS chose the latter course in 1968. 33 Fed. Reg.

4849 (April 16, 1968), which adopted, retroactive for the

years after 1953, Treas. Reg. § 1.482-2. The IRS chose

certain areas in which guidelines would be drawn, and one

of these areas included the issue at bar, the making of

interest-free loans to controlled subsidiaries. Under the

regulations as enacted in 1968, if funds are lent from one

20a

affiliate to another at no charge or at less than an arm’s-

length charge, the district director may make an allocation

of income to reflect an arm’s-length interest rate. Section

1.482-2(a). If the lender is not in the business of lending

money, the arm’s-length charge would be the amount

charged by the taxpayer if it were between 4 and 6 percent.

Section 1.482-2(aX2\i). If no interest charge had been

made, a charge of 5 percent would be imputed, and income

would be thus reallocated among corporate members.

Section 1.482-2(a\2\ii). These regulations were amended in

1975, 41 Fed. Reg. 1280, but those changes do not affect the

tax years at issue here. Thus, after the enactment of Treas.

Reg. § 1.482-2(a), the taxpayer could foresee two occur-

rences—one, when it made an interest-free loan to a

related company it would be liable for a deficiency, and

two, that the IRS would deal with such a liability by

imputing an interest rate.

Section 482 does not, of its own terms, delegate law-

making power, as does § 1502 with respect to consolidated

returns. The nature of the powers there granted we have

recently considered in American Standard, Inc. v. United

States, No. 379-76 (Ct. Cl. June 13, 1979). The respect given

the § 482 regulations in such cases as B. Forman & Co. v.

Commissioner, supra, makes them, when seen as reasona-

ble, little short of laws. They are more than mere

interpretation. They are the nuts and bolts, the girders and

beams, of § 482 operations. In the absence of them, before

1968, a taxpayer could reasonably think that an imputa-

tion of interest, if foreseeable at all, was at the most a

matter at the uncontrolled discretion of the revenue agent

or district director. If there were internal practices or

g lidelines, they were unpublished and the taxpayer had no

obligation to be aware of them. Hence, as to the period

before 1968, counsel’s characterization of the imputation as

discretionary is correct. The essence of the Motor Fuel

Carriers precedent is that the statutory interest provisions

do not contemplate that a taxpayer can or should

anticipate the making of a purely discretionary determina-

tion.

Given the directives of Motor Fuel Carriers, once the IRS

enacted regulations detailing what activities would be

21a

considered a distortion of corporate income, the taxpayer

could self-assess its liability as it was after April 16, 1968,

for this type of transaction, and is liable for the interest on

deficiencies accruing on tax returns filed after that date.

To hold otherwise would unduly favor this taxpayer as

against others who were guided by the regulation in

planning intercompany transactions.

The regulation’s retroactivity to tax years ending after

December 31, 1953, does not alter my position that

taxpayer is not liable for deficiency interest for the years

up until 1968, for until 1968 taxpayer could not self-assess

its potential liability, and this is the criterion by which we

should determine its obligation to report income at the

time of filing returns. Also, the fact that the regulation

contains the permissive language “the district director may

make appropriate allocations” (emphasis supplied) does not

change the taxpayer’s obligation to take notice of these

guidelines at the time it filed its return; this permissive

language protects the district director from being obliged to

reallocate income when to do so woulc not produce

additional revenue. The Commissioner cannot exercise this

kind of discretion in a manner to discriminate between

similarly situated taxpayers. International Business Ma-

chines Corp. v. United States, 170 Ct. Cl. 347, 343 F.2d 914,

cert. denied, 382 U.S. 1028 (1965).

I, therefore, would hold that, under the analysis of Motor

Fuel Carriers, taxpayer has made timely payment under

either § 6601(a) or the present § 6601(e)(3) for the tax years

1965-1967, and may recover interest paid on deficiencies

assessed for those years. I agree that taxpayer may not

recover interest paid on deficiencies for the years

1968-1973.

22a

APPENDIX A

Assessed Deficiency Against Morton-Norwich

and Interest Due

Interest

Tax Year Tax Attributable Date(s)

or Period Attributable to Sec. 482 Date(s) of

Ending __to Sec. 482 Tax of Notice Payment

12/31/65 $ 169,409 $ 97,385 9/09/75 9/22/75

6/ 30/66 128,493 70,009 9/09/75 9/22/75

6/30/67 292,769 147,959 12/01/75 12/01/75

6/30/68 343,497 136,641 5/02/75 .5/19/75

4/24/69 280,383 94,713 5/02/75 5/19/75

6/30/69 44,586 17,825 1/29/76 2/17/76

6/30/70 31,234 10,613 1/29/76 2/17/76

6/30/71 351,780 98,421 1/29; 76 2/17/76

6/30/72 315,506 72,321 3/17/76 3/29/76

6/25/76 7/23/76

6/30/73 273,465 46,277 3/17/76 3/29/76

6; 25/76 7/23/76

TOTAL = $2,231,122 $792,164

APPENDIX B

IN THE UNITED STATES COURT OF CLAIMS

No. 83-77

MORTON-NORWICH PRODUCTS, INC.

THE UNITED STATES

Before NICHOLS, Judge, Presiding, KUNZIG and BEN-

NETT, Judges.

ORDER

This case comes before the court on plaintiff's motion, filed

August 3, 1979, for rehearing en banc pursuant to Rules 7(d)

and 151(b), with reference to the decision entered herein on

July 18, 1979. Upon consideration thereof, together with the

response in opposition thereto, without oral argument, by the

seven active Judges of the court as to the suggestion for

rehearing en banc under Rule 7(d), which suggestion is denied,

and further having been so considered by the panel listed above

as to the motion for rehearing under Rule 151(b).

IT IS ORDERED that plaintiff's said motion for rehearing

is denied.

BY THE COURT

/s/_ PHILLIP NICHOLS, JR.

PHILLIP NICHOLS, Jr.

Judge, Presiding

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