Petition — Berkley Machine Works & Foundry Co. v. Commissioner
Supreme Court brief1980
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Supreme Court, U. S.
FILED
80-199 / AUG 81980
scxcrittiaietaasiaaiiisiitdii asi
IN THE
Supreme Court of the United States
OctoBeR TERM, 1980
BERKLEY MacHInE Works & Founpry CoMPany,
Petitioner,
¥-
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR
THE FOURTH CIRCUIT
ELLswortH T. SIMPSON
Bowen Building, Suite 500
815 Fifteenth Street, N. W.
Washington, D. C. 20005
(202) 393-2244
Attorney for Petitioner.
Preuss or Byron 8. ADAMS PRINTING, INC., WASHINGTON, D. C.
i
QUESTIONS PRESENTED
(1) Whether the fact that the appellate court was
divided in reversing the United States Tax Court,
establishes, as a matter of law, that the appellate
court did not have a, ‘‘definite and firm conviction’’,
that the trial court was ‘‘clearly erroneous’”’ as re-
quired under Commissioner v. Duberstein 363 U.S.
278,291; 80 S.Ct. 1190; 4 L.Ed. § 1218 (1960) ?
(2) Sinee Respondent concedes that Petitioner’s
entertainment facilities were used, ‘‘primarily for the
furtherance of its business,’’ (§ 274(a)(B) LR.C.
1954) and that the expenditures were, ‘‘ordinary and
necessary’’ business expenses (§ 162 I.R.C. 1954) and,
absent any claim that these facilities were used for
personal reasons, does not the appellate court’s deci-
sion contravene the legislative purpose of § 274 LR.C.
1954?
(3) Where, as here, the appellate court’s findings
are contrary to the evidence of record, does this not
foreclose a determination that the appellate court had,
‘definite and firm conviction’’, that the trial court
had made a mistake?
(4) Having conceded that Petitioner did not abuse
entertainment deductions, may Respondent, nonethe-
less, propose income tax deficiencies by means of ad-
ministrative regulations?
(5) Did not the appellate court’s refusal to accept
the court’s findings of fact, coupled with its failure to
view the evidence in a light most favorable to Peti-
tioner, usurp the function of the trial court, contrary
to Rule 52(a) Federal Rules of Civil Procedure?
ii
(6) Inasmuch as Treasury Regulation 1.274-5(b) (1)
(iv) only required Petitioner to substantiate the,
‘‘business relationship’’ of each person entertained
and, since the trial court found, that the persons were
employees of Petitioner’s corporate customers, did not
the appellate court misconstrue these regulations by
requiring Petitioner to identify, by name, each em-
ployee involved in the entertainment?
TABLE OF CONTENTS
Page
COTUOND EUMORNTRD Slee ces ct cceeeusesacbacwe i, ii
OPINIONS 0 re oer Pee ny PT Pee Rr ee 1
I ee eae sak ea soe eae ea eae 2
Sratures, TREASURY ReGuLaTions AND Rute INvoLvep. 2
Praseinsr of Si Ce . dis s:.0cas downer de ceccouraes 2-4
REASONS FoR GRANTING Writ or CERTIORARI ....... .. 48
RS 0 eo re ee ote id oe 10
TABLE OF AUTHORITIES
CasEs:
Bingham v. Commissioner, 325 U.S. 365 (1945) ...... 6
Commissioner v. Duberstein, 363 U.S. 278, 291; 80 S.Ct.
ROS RAM Oe ABED wen cc vicccunceteekenoeven 4
Dowell v. United States, 522 F.2d 708, 716 (C.A. 5
1975) Certiorari denied 426 U.S, 920 (1976) ..... 3
George Durgom, Vol. 43, T. C. Memorandum Decisions
(Prention-<ieen FY TEMG) 2... ccs ockbebesoeeeaewes 6
Heininger v. Commissioner, 320 U.S. 467, 470 (1943).. 6
Kornhauser v. U.S., 276 U.S. 145, 72 L.Ed. 505, 48
ie: SIG CA as bs 5. cada ee 6
Koshland vy. Helvering, 298 U.S. 441, 446-447 56 S.Ct.
FOr, Tee TT Oe Ente, BBUD oo is cesucasnnscekers 7
Manhattan (General Equipment) Co. v. Commissioner,
297 U.S. 129, 134, 56 S.Ct. 397, 399, 80 L.Ed. 528.. 7
United States v. Calamaro, 354 U.S. 351, 359, 77 S.Ct.
ye St ee ge | ere ere eee 7
United States v. National Association of Real Estate
Boards, 339 U.S. 485, 495-496 (1950) ............ 4
U.S. v. United States Gypsum Company, 333 U.S. 364
CRUE 0s 6b Cada Wake vaseenaks vekakhareakdead baa 4
Whipple et ux v. Commissioner of Internal Revenue,
373 U.S. 193 at 203, 204 (1963) ....... cc eee eee 4
Zenith Radio Corporation v. Hazeltine Research, Inc.
395 U.S. 100
No.
IN THE
Supreme Court of the United States
OctToBER TERM, 1980
BrERKLEY MAacHINE Works & Founpry CoMPANY,
Petitioner,
Vv.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR
THE FOURTH CIRCUIT
Petitioner, Berkley Machine Works and Foundry
Company, prays that a writ of Certiorari issue to
review the judgment of the United States Court of
Appeals for the 4th Circuit entered in the above-
entitled cause on June 2, 1980 which reversed a judg-
ment entered on June 13, 1977 by the United States
Tax Court.
OPINIONS BELOW
The Findings of Fact and Memorandum Opinion
of the United States Tax Court (App. A, infra., pp.
la to 3la inel.) is unofficially reported in T.C. Memo-
randum Decisions, Vol.46, Prentice-Hall. The opinion
of the United States Court of Appeals for the 4th Cir-
2
euit (App. B, infra: pp. 32a to 50a incl.) is reported
in —— Fed. 2d ——.
JURISDICTION
The jurisdiction of this Court is invoked under
28 U.s.C. § 1254(1).
STATUTES, TREASURY REGULATIONS AND
RULE INVOLVED
The statutory provisions, Treasury Regulations and
Rules involved are:
Sections 162(a) and 274 I.R.C. 1954
Treasury Regulations,
§ 1.274-2(¢) (3)
§ 1.274-2(¢) (4)
§ 1.274-2(4) (i) and (iii)
§ 1.274-5(3) (iv) and (v)
§ 1.274-5(¢) (2)
Federal Rules of Civil Procedure 52(a)
The foregoing statutes, Treasury Regulations and
Federal Rules of Civil Procedure are printed in App.
C infra., pp. 51a to 57a inel.
STATEMENT OF THE CASE
For the years 1963-1967 inclusive, the Commissioner
of Internal Revenue proposed deficiencies against
Petitioner for corporate income taxes aggregating
$100,000. These deficiencies were based upon disal-
lowances of certain entertainment expenses incurred
by Petitioner in entertaining executive officers and
other employees of its longstanding major customers
3
at its hunting and fishing lodges located on Ocracoke
Island, off the coast of North Carolina. Petitioner’s
business is that of manufacturing metal castings and
forging, including the operation of a foundry for steel,
brass and iron in Norfolk, Virginia where it also
maintains its principal offices. Respondent concedes
that Petitioner’s Ocracoke facilities were used, ‘‘pri-
marily for the furtherance of its business’’ and that
the expenditures relating thereto were deductible as,
‘‘ordinary and necessary’’ business expenses under
§ 162 I.R.C. 1954; Respondent makes no claim that
these facilities were used for personal reasons and
there is no allegation that Petitioner abused the In-
ternal Revenue laws. Respondent also concedes that
Petitioner’s books and records clearly reflect the ele-
ments of time, place, and amount but contends that
Petitioner failed to prove ‘‘business purpose’’ and
‘‘business relationship.’’ In this regard, Respondent
relied upon Dowell v. United States 522 Fed.2d 708,716
(5th Cir., certiorari denied 425 U.S.920 (1976). A
trial on the merits was held in October 1975, after
which the United States Tax Court found that the
major portion of Petitioner’s entertainment activity
and facility expenses were directly related to the ac-
tive conduct of its business and were substantiated
as required by § 274(a) and (d) I.R.C. 1954. The Tax
Court rejected Respondent’s contention that Petition-
er’s expenses were in the nature of good will (App. A,
p. 19a).
At the trial, executives of Petitioner’s major cus-
tomers, such as Weyerhauser, Drill Carrier Corpora-
tion and Union Bag Camp, testified that on each
occasion that they were guests at Petitioner’s Ocracoke
facilities, meaningful business discussions were held
4
with Petitioner’s officers and sales representatives.
The testimony of these witnesses was not contradicted
by Respondent.
REASONS FOR GRANTING THE WRIT
Contrary to the findings of the United States Tax
Court, the appellate court found that Petitioner had no
more than ‘‘a general expectation of deriving some in-
come or other specific trade or business benefit’’ other
than good-will at some indefinite future time (App. B
p. 41a). By substituting its findings for those of the
trial court, the appellate court failed to abide by the
instructions set forth in Zenith Radio Corporation v.
Hazeltine Research, Inc, 395 U.S. 100, wherein, inter
alia, this Court stated that, ‘‘The authority of an ap-
pellate court, when reviewing the findings of a Judge,
as well as those of a jury, is circumscribed by the
deference it must give to decisions of the trier of fact
who is usually in a superior position to appraise and
weigh the evidence’’; continuing, this Court said, ‘‘The
question in the Appeals Court under Rule 52(a) is not
whether it would have made the findings the Trial
Court did, but whether, on the entire evidence [it] is
left with the definite firm conviction that a mistake
has been committed’’, citing U.S. v. United States
Gypsum Company, 333 U.S. 364, (1948). In its opinion,
the United States Supreme Court referred to the deci-
sions in United States v. National Association of
Real Estate Boards, 339 U.S. 485, 495-496 (1950) and
Commissioner v. Duberstein, 363 U.S. 278, 289-291
(1960). To the same effect, Whipple v. C.I.R., 373 U.S.
193 at 203 (1963).
As trier of the facts, the U.S. Tax Court found that
Petitioner had, by adequate records and other evi-
5
dence, satisfactorily substantiated the business pur-
pose of the Ocracoke expenditures including the busi-
ness relationship of its guests (App. A p. 27a). The
appellate court, however, ignored these facts and
found that Petiticner ‘‘failed to substantiate ade-
quately the business purpose of the Ocracoke trips
and the business relationship of its guests.’’ (App.
B p. 49a). As to this, the appellate court held that
Petitioner was not entitled to these expenditures be-
cause it did not give the names of the employees of
its customers although it acknowledged that the indi-
viduals were employees of Petitioner’s customers.
While § 274 I.R.C. does not require the name of the
person in order to establish business relationship,
Treasury Regulations § 1274-5(3) provides in perti-
nent part: ‘‘Entertainment in general.’’ Elements to
be proved with respect to an expenditure for enter-
tainment are—
(v) Business relationship. Occupation or other
information relating to the person or persons
entertained, including name, title, or other desig-
nation, sufficient to estublish business relationship
to the taxpayer. (Emphasis supplied)
By noting that, ‘‘Berkley’s evidence consisted of
undocumented recollections by witnesses whose memo-
ries were clouded by the passage of time .. .’’ (App.
B p. 42a) the appellate court introduces an element
not required by the Internal Revenue Code, nor those
of the Treasury Regulations, namely, that of requiring
documentation of business discussions (Emphasis sup-
plied).
In holding that Petitioner’s expenses were not di-
rectly related to the active conduct of its business,
6
the appellate court disregarded the instructions of
this Court in Kornhauser v. U.S. 276 U.S. 145, 72
L.Ed. 505 48 8.C. 219 (1928); Heininger v. Commis-
sioner 320 U.S. 467,470 (1943); Bingham v. Commis-
sioner 325 U.S, 365 (1945) wherein it is stated that
expenses must be, ‘‘directly connected with”’’ or proxi-
mately resulting from the trade or business in order
to qualify as ‘‘ordinary and necessary’’ business ex-
penses. Having conceded that the expenses were ‘‘ordi-
nary and necessary,’’ the appellate court erroneously
concluded that Petitioner’s expenditures were not
‘*directly related’’ to the active conduct of its business.
Having qualified as, ‘‘ordinary and necessary”’’ ex-
penses they must, of necessity, have been directly re-
lated to the active conduct of Petitioner’s business.
By virtue of inherent contradictions in its decision,
including its refusal to abide by the ‘‘clearly errone-
ous’’ rule, and by disregarding this Court’s criteria
for determining the directly relatedness of an expendi-
ture, the appellate court has compounded the confu-
sion already existing as to ‘‘prolix and convoluted”’
regulations; they were so described by the United
States Tax Court in Durgom, Vol. 43, T. C. Memoran-
dum Decisions (Prentice-Hall {1 74,058).
Because of their complex nature, these regulations,
create confusion often resulting in questionable assess-
ments of income taxes. The well-publicized legislative
purpose underlying the enactment of § 274 IRC 1954
was to prevent abuses in entertainment deductions.
Toward this end Congress acted to prevent personal
benefits under the guise of business entertainment. In
the instant case, Petitioner’s officers scrupulously
avoided any personal benefit and Respondent makes no
claim that the revenue laws were abused in this respect.
7
Once Respondent concedes that there has been no
abuse of the Internal Revenue Code, it has discharged
its duty in safeguarding the revenue. It should not be
within its authority to propose tax deficiencies by way
of regulations, the enforcement of which countermands
Congressional intent. § 274 I.R.C. 1954 does not require
a taxpayer to submit the names of persons who have
been entertained as a rigid condition for complying
with this provision. Approval of Respondent’s actions
in this regard is tantamount to upholding a tax by
means of a regulation which, of course, the law does
not permit. United States v. Calamaro, 354 U.S. 351,
309 [77 S.Ct. 1138, 1148 1 L.Ed2d 1394]; Koshland v.
Helvering, 298 U.S. 441, 446-447 [56 S.Ct. 767, 769-
770; 80 L.Ed. 1288]; Manhattan (General Equipment )
Co. v. Commissioner, 297 U.S. 129, 134 [56 S.Ct. 397,
399, 80 L.Ed. 528]. Additionally, pending before the
United States Tax Court are two cases involving the
same issue, notwithstanding the fact that Petitioner
made available to Respondent the names of the em-
ployees of Petitioner’s corporate customers. The pro-
posed additional assessments of income taxes in these
pending cases, including accrued interest, exceeds
$500,000.
In holding that Petitioner’s, ‘‘corroborative evi-
dence consisted of only nine of some 1,000 guests dur-
ing the relevant years, their testimony related to only
12 of 76 trips’’ (App. B, p. 47a), the appellate court
adopted Respondent’s erroneous calculations, thereby
reaching an obviously incorrect result. Specifically, on
direct examination, the nine executives referred to by
the appellate court, testified that, with few exceptions,
they themselves were guests in each of the five years
involved in this proceeding. (App. D pp. 582a-67a
8
incl.). On cross examination, Martin Ellers, Vice Presi-
dent, Drill Carrier Corporation, testified that he and
other Drill Carrier employees were Petitioner’s guests
as many as 3 times in each of the five years. (App. E
p. 68a). On cross examination, A. J. Scott, an American
Oil Company official, one of Petitioner’s customers, tes-
tified that he had been a guest at Ocracoke Island 12 or
15 times during the relevant five-year period. (App. E
p. 68a). On cross examination, John Lee Wood, me-
chanical engineer for Drill Carrier Corporation, testi-
fied that he was a guest at least twice in some of the
five years involved herein. (App. E p. 69a). On cross-
examination Jerry Polk, Maintenance Superintendent
for Weyerhaueser Company, testified that he was a
guest more than once a year during 1964-1967 inclusive
(App. E p. 69a). On cross examination, Richard H.
Deal, project engineer for Albemarle Paper Company,
testified that he had been Petitioner’s guest several
times. (App. E p. 69a). Each of these nine witnesses
identified, by name, a total of 34 other employees of
Petitioner’s customers whom they recalled were Pe-
titioner’s guests while they were guests at Petitioner’s
facility. In concluding that there were 1,000 guests,
the appellate court erroneously multiplied the same
individual (guest) by the number of trips he made
during the five-year period. By failing to make an
independent review of the record, the appellate court
departed from the accepted and usual course of ju-
dicial proceedings. By reason thereof, it reached an
incorrect result in evaluating the testimony adduced
at the trial. It is respectfully submitted that the ap-
pellate court could not, within the acceptable meaning
of the rule, have had an independent, ‘‘definite and
firm conviction that the Tax Court’s decision was
‘clearly erroneous.’ ”’
In reversing the United States Tax Court, the ap-
pellate court, as did Respondent, relied upon Dowell v.
United States, supra relative to the elements of ‘‘ busi-
ness purpose’”’ and ‘‘ business relationship.’’ In the case
at bar, Respondent concedes, and the appellate court
concurs, that Petitioner satisfied the requirements as
to amount, date, and place. The appellate court’s re-
liance, however, upon Dowell as authority for holding
that Petitioner failed to substantiate ‘‘business pur-
pose”’ is misplaced. Specifically, the Dowell case holds
that ‘‘business purpose’’ may be substantiated by trial
testimony ; the record in this proceeding is replete with
such testimony.
Although the appellate court concluded, ‘‘that the
claimed expenses, while undoubtedly business-related’”’
—(App. B, p. 3Za), it found, nonetheless, that they
were not properly established on the evidence as di-
rectly related to the active conduct of its business.
* * * (App. B, p. 41a). Having acknowledged that
Petitioner’s expenses were ‘‘business related,’’ it fol-
lows that the element of ‘‘business purpose’’ has been
substantiated as required by Treasury Keguiaiion
1.274 5(b) (iv) (App. C, pp. 56a, 57a) and as inter-
preted by the 5th Cir. in Deweii v. U.S., supra.
In Dowell, the 5th Circuit held that ‘‘business pur-
pose’’ had been established even though names, dates,
amount and place were not submitted. In view thereof,
Dowell actually supports Petitioner as to the element
of ‘‘business purpose’’; consequently, the appellate
court’s holding on the issue of substantiation in this
proceeding conflicts with that reached by the 5th Cir-
cuit in the Dowell case.
10
CONCLUSION
For the foregoing reasons, it is respectfully sub-
mitted that the petition for a writ of certiorari in this
case should be granted.
Respectfully submitted,
ELLswortH T. SIMPSON
Bowen Building, Suite 500
815 Fifteenth Street, N. W.
Washington, D. C. 20005
(202) 393-2244
Attorney for Petitioner.
APPENDIX
la
APPENDIX A
T. C. Memo. 1977-177
UNITED STATES TAX COURT
BerkKLey Macuine Works & Founpry Company, Inc.,
Petitioner,
Vo
CoMMISSIONER OF INTERNAL Revr ivr, Respondent.
Docket Nos. 967-72 and 1248-73
Filed June 13, 1977
Petitioner owned and maintained three buildings on
Ocracoke Island, North Carolina, which it used as hunting
and fishing lodges, for the entertainment of employees of
its major customers during 1963 through 1967, Held, the
major portion of petitioner’s entertainment activity and
facility expenses were directly related to the active con-
duct of its business and substantiated as required by sec-
tion 274(a) and (d), I.R.C. 1954. Petitioner is entitled,
consequently, to deductions for depreciation and ordinary
and necessary business expenses as determined. Held fur-
ther, respondent erroneously disallowed an investment
credit claimed by petitioner with respect to an airplane
purchased by it in 1967. Held further, repair expense or
capital nature of certain payments with respect to manu-
facturing equipment used at petitioner’s plant determined.
Ellsworth T. Simpson, for the petitioner.
Nancy Mattox McMurrer, for the respondent.
2a
Memorandum Findings of Fact and Opinion
Bruce, Judge: Respondent determined deficiencies in
petitioner’s Federal corporate income taxes as follows:
Docket No. Year Deficiency
1248-73 1963 $16,849.45
1964 22,193.27
967-72 1965 48,339.78
1966 63,518.31
1967 62,956.39
The cases have been consolidated for trial, briefing, and
opinion pursuant to a joint motion of the parties. Each
party has made certain concessions regarding the defi-
ciencies that we are to redetermine. The following issues
remain for our resolution:
(1) Whether certain deductions claimed by petitioner
in connection with an entertainment facility maintained
and activities conducted at Ocracoke Island, North Caro-
lina, are allowable as ordinary and necessary business ex-
penses in 1963 through 1967, inclusive;
(2) Whether petitioner is entitled to an investment credit
with respect to an airplane purchased by it in 1967;
(3) Whether certain payments made by petitioner in
connection with its equipment in 1965 and 1966 constitute
currently deductible repairs expenses or capital expendi-
tures subject to an allowance for depreciation.
Findings of Fact
Some of the facts have been stipulated by the parties
and they are so found. Unless otherwise noted the follow-
ing facts are of general applicability to all the years
involved in this proceeding.
3a
The petitioner, Berkley Machine Works & Foundry Com-
pany, Ine., was incorporated in 1914 under the laws of the
Commonwealth of Virginia. It maintains its principal of-
fices in Norfolk, Virginia, where its plant is also located.
Petitioner timely filed its corporate income tax returns
for the calendar years 1963 through 1967, utilizing the
accrual method of accounting, with the district director of
internal revenue at Richmond, Virginia.
Samuel G. Jones, Sr., has been petitioner’s president
since 1919, and during 1963 through 1967 he owned 83 per-
cent of its capital stock. During the relevant years, Samuel
G. Jones, Jr., was petitioner’s vice-president and he owned
the remaining 17 percent of its capital stock.
Petitioner’s business involved the operation of a foundry
for iron, steel, brass, and aluminum, including a pattern
shop and a machine shop, and the manufacture of metal
castings and forgings. Berkley manufactured both parts
which other companies used in their production of a fin-
ished product and repair parts for equipment used by
for parts that petitioner manufactured were provided
other companies in their production process. Patterns
for parts that petitioner manufactured were provided
either by existing plans and specifications or by using old
parts as a sample. Petitioner’s ability to acquire a particu-
lar job of manufacturing equipment repair parts was often
dependent upon its ability to produce them more quickly
and less expensively than the original equipment manu-
facturer.
Because of the nature of petitioner’s business, media
advertising was of limited usefulness. The company’s policy
for promoting sales was that of developing and maintain-
ing personal contact with the appropriate personnel of its
customers—individuals often in various departments of
the same company. Berkley’s principal sales efforts were
directed toward a small number of major customers, iden-
tified by name on the following chart depicting petitioner’s
sales:
4a
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5a
Petitioner’s contact with these customers, the frequency
of which varied from as often as three or four times a day
to as seldom as once a week, was maintained primarily
through two sales representatives. E. M. Weber concen-
trated his activities in the area around York, Pennsyl-
vania, where Pennsylvania Railroad and Bowen-McLaugh-
lin-York were lecated. From the Norfolk office, C. M. Halsey
directed the sales effort toward local customers and cus-
tomers located in other southeastern states. However, pe-
titioner’s largest customer, Drill Carrier Corporation, was
serviced by Samuel G. Jones, Jr., and F. P. Huber, the
foundry superintendent.’
One of the means by which petitioner cemented its rela-
tionship with its customers was by use of an entertainment
facility owned and maintained by it on Ocracoke Island.
Ocracoke is an island off the Atlantic Coast of North Caro-
lina, just south of Hatteras. It is an isolated island con-
sisting of a small cluster of homes at one end and a suc-
cession of sand dunes and marshes leading to the other
end. There is no bridge leading from the mainland to the
island, a ferry being the only means of public transporta-
tion to Ocracoke.
Petitioner’s Ocracoke facility consisted of three build-
ings of wood frame construction, the exteriors of which
were covered with fir shingles. Each building was designed
as a home, with a living room, a dining room, and several
bedrooms. The interiors were nicely furnished to reflect
the tastes of Jones, Sr. On the second floor of Berkley
Castle, the largest of the three buildings, was a conference
room containing a drafting board, a large table, and a
number of chairs. Known as Berkley Castle, Berkley
1 Subsequent to the years at issue in this proceeding, Drill Car-
rier Corporation was purchased by the Gardner-Denver Corpora-
tion. Prior to the merger, Gardner-Denver was the primary mar-
keting force for Drill Carrier’s product.
6a
Manor, and Berkley Ranch House, the three buildings were
used as hunting and fishing lodges.
During 1963 through 1967, employees from all of pe-
titioner’s major customers (except Texas Gulf Sulphur)
and from a few of its smaller customers were invited by
petitioner’s officers and sales representatives to visit the
Ocracoke facility for hunting and/or fishing trips. On oc-
casion petitioner’s business associates would be accom-
panied by members of their families, or other guests having
no direct business relationship with petitioner. The num-
ber of guests present at a single time varied between
about 6 and 30, the general number approaching the arith-
metical mean of these extremes. Guests typically received,
as mementos of their Ocracoke visit, gifts distributed by
petitioner such as hunting and fishing knives, model ducks
to be used as doorstops, cookbooks or other books, and
neckties with a Berkley label.
Petitioner’s Ocracoke facility was used throughout the
year, but primarily on weekends from late spring through
early fall. However, guests were not invited each and every
week even during this period. A typical fishing trip to
Ocracoke began on Thursday afternoon or Friday morn-
ing. After breakfast on Friday, the fishermen split into
teams of four, five, or six and fished until lunchtime from
boats chartered by petitioner from various individuals
who were engaged in the business of taking out fishing
parties off the coast of North Carolina. The fishermen
returned to Berkley’s facility for lunch, and then resumed
fishing for the remainder of the afternoon. Saturday’s
activities duplicated those of Friday. Guests generally left
the island after breakfast on Sunday.
The Ocracoke setting established a congenial and relax-
ing atmosphere in which petitioner’s sales representatives
pursued petitioner’s business interests, i.e. promoting
sales. Business discussions often centered around specific
jobs that Berkley was in the process of performing for its
7a
customer-guests. At other times determinations were made
whether Berkley could perform specific jobs which the cus-
tomer-guests needed done. On occasion petitioner’s guests
would initiate discussions about problems that arose only
a few days prior to their trip to Ocracoke, after the visit
had been plannd. The conference room in Berkley Castle
was used when examination of plans and specifications
was pertinent. Discussions of anticipated business needs
and job scheduling were conducted in even less formal sur-
roundings, e.g. on the fishing boats, during meals, and
while relaxing after dinner.
In composing the parties to be invited to Ocracoke on a
particular occasion, Berkley’s representatives sometimes
included employees from several different customer-com-
panies. By so mixing its guests, petitioner was able to
make certain customers aware of the work that it was per-
forming for others—the underlying purpose of which was
to inform each company of the different and additional
types of work that petitioner could do for it.
Business guests visiting Ocracoke believed the trips there
to be meaningful and beneficial to both their employers
and to Berkley because of the actual substantive matters
discussed and resolved and also because of the informa-
tion they received about various other functions that
Berkley could perform for them.
In addition to Berkley’s Ocracoke facility, petitioner’s
president and major stockholder, Samuel G. Jones, Sr.,
owned and maintained a vacation home elsewhere on the
island. Although it was usual for Jones, Sr., to attend the
Berkley facility while guests were being entertained, he
did not participate in the hunting or fishing and he re-
turned to his personal residence in the evenings.’ Peti-
? Mrs. Jones, Sr., visited the personal residence for only three
or four weeks each summer, and she was apparently not connected
in any manner with Berkley’s entertainment activities on the
8a
tioner’s Ocracoke facility was not used by Jones, Sr.,
members of his family or other Berkley employees for
entertainment unrelated to the advancement of Berkley’s
business. Respondent has conceded that the Ocracoke fa-
cility was used primarily for the furtherance of petitioner’s
trade or business.
Petitioner employed a caretaker to oversee the opera-
tion of its Ocracoke facility. The caretaker was respon-
sible for preparation of the facility for use by petitioner’s
representatives and guests, which, when appropriate, in-
cluded chartering the required number of fishing boats.
Other islaviders were hired to do cleaning, laundering, and
the cooking and serving of meals at the facility. The care-
taker collected bills for the various expenses incurred on
the island, e.g. boat charter fees, restaurant meals, and
groceries, and forwarded them to petitioner’s Norfolk
office for payment.
Most of the expenditures in connection with petitioner’s
Ocracoke facility and entertainment activities (other than
payroll and capital expenditures) were charged to two
expense accounts: promotional sales and Berkley Manor
supplies.* The cash receipts and disbursements journals
and general expense ledgers in which these accounts were
maintained were kept in the regular course of petitioner’s
business and conformed to generally accepted accounting
principles. In addition to the corporate books, which con-
tain the data of each expenditure, petitioner retained the
complementary invoices, receipts, and petty cash vouchers
and reimbursement sheets which support the book entries
island. No contention has been advanced by respondent that any
expenses related to the personal residence are included in the
amounts at issue herein.
*The promotional sales account was not used exclusively ‘o
record expenditures related to Ocracoke, and this fact gives rise
to the first matter discussed under the Opinion heading infra.
‘*Berkley Manor Supplies’’ was a code name used by petitioner
to refer to its entire Ocracoke facility.
9a
for these accounts. Many of the cash journal entries and
related documents contain a notation of the Ocracoke
guests to whom the expenditures relate. Other documents,
supporting expenditures for quantities of items to be used
over the course of several Ocracoke visits, do not contain
the names of particular guests.
The total amounts disallowed by respondent and remain-
ing in dispute in connection with petitioner’s entertainment
activities and facility at Ocracoke are set forth below in
Table 2:
TABLE 2
1963 1964
Expenditures .......... $ 7,389.01 $ 4,133.29
Depreciation .......... 23,096.60 30,469.58
$30,485.61 $34,602,87
1965 1966 1967
‘Promotional Sales,’’ einai
Snes ctece $ 10,164.88 21,967.66 24,738.20
Miscellaneous .......... 795.97 915.02 \ aa
EE hea bn cc ete es 205.26
EE Ser ae is cciad sane 533.00 117.43
SS ee 1,334.85 * 8,109.69 9,758.07
EL Obiks od-s-0 466000 14,559.80 30,248.01 24,687.40
N.C. Unemployment Tax
(Ocracoke) ......... 525.69 1,972.17 1,316.21
EE rch 4 béve ses 515.03 1,130.52 979.76
Employee Benefits ...... | 294.80
ED Giesia in dcsiss0s 884.00 1,569.56 943.00
Airplane Expense ...... 5,762.05
Loss on Boat Sale ...... 7,440.17
Depreciation .......... 30,151.18 34,681.76 45,230.37
$ 59,669.66 $106,473.87 $117,618.18
Employee meeting* ..... (1,666.49)
$ 59,669.66 $106,473.87 $115,951.69
* This reduction represents a proportionate part of the Ocracoke
expenses allowed by respondent in the notice of deficiencies due
to an employee meeting held at the facility in 1967.
10a
Neither the amounts of the expenditures nor the cost bases,
useful lives, and salvage values assigned by petitioner to
the assets on which depreciation was claimed are in dis-
pute.
Inasmuch as petitioner maintained no separate diary or
account book relating exclusively to its Ocracoke enter-
tainment, the documented information pertinent to this
litigation has had to be gathered piecemeal from the cor-
porate books and supporting data. These show that peti-
tioner’s Ocracoke facility was used on the following num-
ber of occasions during the years in issue:
TABLE 3
Year Times Used
1963 13
1964 9
1965 17
1966 18
1967 19
With the exception of one use in each of the years 1963,
1965, 1966, and 1967, to be discussed below, each use in-
volved. entertainment of employees of petitioner’s cus-
tomers of the type heretofore described.*
In 1963 at the request of the Ocracoke Civic Club (an
island organization similar to a chamber of commerce),
petitioner allowed one of the club members and two rep-
resentatives of the Interior Department of the Federal
government to stay at its Ocracoke facility. The indi-
viduals were examining the possibility of increased ferry
service to Ocracoke and the possible establishment of an
airport on the island.
’> The entry on Table 3 for 1967 includes the Berkley employees’
meeting held at the Ocracoke facility, an additional variation from
the general use of the facility. Respondent has conceded however,
that the expenses connected with this use of the facility are allow-
able as deductions. See note 4, supra.
lla
In 1965 petitioner hosted a party for a local public figure,
Lindsay Warren, at its Ocracoke facility.
In 1966 petitioner allowed one of its customers, Union
Camp Corporation, to hold an internal sales meeting at its
Ocracoke facility. Although Jones, Sr., and Halsey sat in
on the meeting, this use differed in character from the
regularly conducted entertainment activities at Ocracoke.
In 1967 petitioner entertained some North Carolina leg-
islators at the same time representatives of Atkinson
Dredging Company attended its Ocracoke facility.
Berkley’s expenditures directly connected with these
four uses of its Ocracoke facility are set out in the follow-
ing table:
TABLE 4
Check
Year Entertainee Amount Number
1963 Beasley $ 50.00 34051
85.00 34183
1965 Warren 80.00 40507
60.40 40523
15.00 40538
1966 Union Camp 25.53 43180
: (internal sales meeting) 18.63 43179
10.00 43092
191.61 43091
179.20 43223
1967 N.C. legislators & 294.33 47508
Atkinson Dredging Co. 18.54 47446
18.20 47468
90.00 47506
27.63 47512
4.84 47511
36.00 47438
5.01 47613
30.00 47496
12a
Although the business motivation for each of these uses is
apparent, petitioner has failed to demonstrate that the
expenses attributable thereto were incurred in the active
conduct of its business.
The entries in Table 5 below represent amounts that
respondent argues on brief were not ordinary and neces-
sary business expenses:
Tasie 5
Year Amount
1963 $ 529.53
1964 371.00
1965 356.66
1966 5,710.33
1967 2,434.74
These expenses relate to sundry items recorded in peti-
tioner’s promotional sales and Berkley Manor supplies
accounts, but in large part to expenditures for photo-
graphic services and supplies, waitress costumes, the
Beasley and Warren visits in 1963 and 1965, respectively,
and gifts distributed at Ocracoke. The expenditures for
gifts are further set forth in the following table:
TasLe 6
Year Amount Check Number
1963 $ 49.50 33025
1965 105.85 40407
1966 92.87 42597
255.60 44100
1,954.50
49.05 43550
1967 8.00 46806
10.00 47095
40.00 47580
50.00 47356
289.32 48512
20.00 47510
153.84 47679
13a
The entries in Table 7 below represent amounts recorded
in petitioner’s promotional sales accounts which petitioner
maintains were unrelated to its Ocracoke entertainment
and, consequently, erroneously disallowed by respondent:
TABLE 7
Year Amount
1963 $287.64
1967 23.23
With the exception of a $9.06 expenditure for photographic
supplies in 1963, the amounts contained in Tables 5 and 7
relate to different expenditures. The remaining expendi-
tures represented by the 1963 entry were for items, largely
foodstuffs, of the type generally used at Ocracoke. The
1967 entry represents the cost of a restaurant meal for
the Ocracoke caretaker and eight other Ocracoke em-
ployees.
_ Included in the total depreciatioa disallowed by respon-
dent for 1967 is $1,441.46 claimed by petitioner with respect
to an airplane purchased by it at a cost of $86,487.90 in
that year. Also disallowed was an investment credit of
$6,054.14 claimed by petitioner with respect to the airplane.
Both items were disallowed based on respondent’s deter-
mination that the airplane was purchased for use in con-
nection with petitioner’s Ocracoke entertainment activities.
Expenditures on Machinery
In 1965 petitioner incurred expenses of $7,906.88 in
. connection with a model 4-A Warner & Swasey turret lathe
owned and operated by it at its Norfolk plant. A turret
lathe is a high production piece of equipment used in the
manufacture of metal parts to cut them within required
tolerances. The machine in question was very large and in
order to disassemble some of its components the use of
14a
overhead cranes was necessary. The turret lathe was re-
moved to the plant of Precision Rebuilding Corporation
where that company performed the work necessary to re-
turn the machine to the accuracy required for Berkley’s
use. Included in the total expenditure, all of which was
claimed by petitioner as an ordinary and necessary busi-
ness expense, was $736.29 which represented the cost of
a modification to permit the turret lathe to use tools that
it could not use before.
Precision Rebuilding Corporation performed two dif-
ferent services for its customers: rebuilding of machines
and maintenance of machines for smaller companies, like
Berkley, which did not have their own maintenance crews.
Rebuilding Berkley’s turret lathe would have cost between
$24,000 and $25,000. The service that was performed, how-
ever, with the exception of the $736.29 expenditure, merely
kept Berkley’s machine in efficient operating condition
without adding to its value or appreciably prolonging its
useful life.
In 1966 petitioner incurred expenses of $13,661.84 for
parts in connection with a wheelabrator machine located
at its Norfolk plant. A wheelabrator machine is used for
the blast cleaning of castings after they have been shaken
out of a mold. It operates by throwing steel shot or steel
grit media at the castings from a wheel at high velocities.
By the nature of the work it performs, a wheelabrator is
a somewhat self-destructive machine and it requires the
replacement of liners and various component parts to stay
in efficient operating condition. The parts purchased by
Berkley were such necessary parts. They did not materially
increase the value of the machine or extend its useful life.
Also in 1966, petitioner incurred expenses of $6,826.00
with respect to a lectromelt furnace used in its Norfolk
plant. A lectromelt furnace is an electric furnace used to
melt steel from which castings are poured. An armature
for the D.C. generator used in the melting processing cost
15a
$726.00. The remainder of the expenditure, $6,100.00, was
for a new furnace shell, the vessel in which steel is melted.
A furnace shell is a separate unit of the larger furnace,
itself made up of component parts. The new furnace shell
replaced one that had been in use for about 20 years.
Opinion
During 1963 through 1967, petitioner owned and main-
tained three buildings on Ocracoke Island, North Carolina,
where it regularly entertained employees of its major cus-
tomer companies. Petitioner incurred substantial expenses
in connection with it Ocracoke entertainment and claimed
deductions therefor as depreciation and ordinary and nec-
essary business expenses. In his statutory notices of de-
ficiencies, respondent disallowed “in accordance with sec-
tion 274 of the Internal Revenue Code”®* deductions for
the sums he determined to be “Ocracoke expenditures.”
The primary issue in this case is whether petitioner’s
Ocracoke-related entertainment expenses are deductible
under the provisions of section 274. With certain excep-
‘tions, we hold for petitioner. Before proceeding to a dis-
cussion of section 274 and the bulk of the expenditures at
issue, however, we think it appropriate to resolve the
proper categorization of the expenses represented on
Tables 5 and 7.
Table 7 represents a portion of the total amounts dis-
allowed by respondent as “Ocracoke expenditures” which
petitioner maintains were deductible expenditures unre-
lated to its Ocracoke entertainment.’ The 1963 expenditures
at issue here were for items, largely foodstuffs, of the type
* All statutory references are to the Internal Revenue Code of
1954, as amended and in effect during the years in issue.
* Petitioner claimed at trial that additional expenditures orig-
inally disallowed were non-Ocracoke related, but with the excep-
tion of those on Table 7, respondent has so conceded.
l6a
generally used at Ocracoke, however, and petitioner has
offered no explanation of why it considers them non-Ocra-
coke related. We think they must be considered Ocracoke
expenditures. The only other entry on Table 7, $23.23 in
1967, represents the cost of a restaurant meal for the
Ocracoke caretaker and eight other Ocracoke employees.
This expenditure is properly considered apart from the
other Ocracoke expenditures, but at least in view of our
ultimate conclusion about the nature of petitioner’s Ocra-
coke entertainment, its deductibility is sanctioned by sec-
tioned 274(e)(5) and section 1.274-2(f)(2)(v), Income Tax
Regs., relating to expenses for employees.*
Respondent, meanwhile, has mounted a multi-faceted
attack on the expenditures represented by Table 5. Phras-
ing his argument generally in the terminology of section
162, respondent argues that petitioner failed to show how
the expenditures represented by Table 5 related to the
entertainment of its customer-guests at Ocracoke. While
respondent may be technically correct, in that no one testi-
fied specifically as to the purpose of these expenditures,
each of them is included in petitioner’s records introduced
at trial and identified by petitioner’s head bookkeeper and
office manager to be Ocracoke expenditures. Furthermore,
it requires no stretching of the imagination to relate pho-
tography with hunting and fishing trips or waitress cos-
tumes with waitresses serving meals in the Ocracoke fa-
cility dining room.
Most important in this regard, however, is respondent’s
failure to designate prior to trial which expenses he
thought not ordinary and necessary. The notices of defi-
ciencies stated that “Ocracoke expenditures” were being
disallowed “in accordance with section 274.” Section 274
* As indicated by our prior notation of the virtual lack of
mutuality between the expenditures represented by Tables 5 and
7, respondent does not argue that this expenditure was not an
ordinary and necessary business expense.
17a
being strictly a disallowance provision, before its terms
became applicable, a deduction must be allowable under
some other provision of the Code. Sanford v. Commis-
sioner, 50 T.C. 823, 826 (1968), affd. per curiam 412 F. 2d
201 (2 Cir., 1969), certiorari denied 396 U.S. 841 (1969).
See section 1.274-1, Income Tax Regs. Respondent did sug-
gest in his trial memorandum that some of the expenses
involved might not meet the requirements of section 162,
but it was not until his initial brief was filed that he desig-
nated which expenses he had in mind. As a comparison of
the totals from Table 2 and Table 5 reveals, particularly
in light of the Table 5 expenses which must be disallowed
on other grounds, the expenses now challenged on the basis
of section 162 make up a rather small portion of the total
expenditures in issue. As a practical matter neither the
Court nor, we are sure, either of the parties would want
an already burdensome record to be further burdened with
questions and answers with respect to each expenditure
if its.business nature was not in dispute.’ Under the cir-
cumstances we think the record supports the allowability
of the Table 5 expenses as ordinary and necessary business
expenses.””
Although we reject respondent’s section 162 argument,
we nevertheless sustain his determination that deductions
for the expenditures represented on Table 6 must be dis-
allowed. In his notices of deficiencies, respondent allowed
petitioner deductions each year for business gifts in the
lesser of the amount claimed or $2,500.00. Table 6 contains
the costs of various gifts distributed at Ocracoke which
petitioner has not shown satisfy the restrictions of sections
* Cf. Lickert v. Commissioner, T.C. Memo 1964-47,
Lest it not be clear, respondent’s argument is based upon
petitioner’s failure to prove the relationship between these ex-
penses and entertainment of its customers. Had respondent seen
his way clear to develop the record with affirmative evidence, his
argument might well stand in a different light.
18a
274(b)" and (d), and the regulations promulgated there-
under.
We come now to consideration of section 274 and deduc-
tibility of the expenses incurred by petitioner in connec-
tion with its Ocracoke facility and entertainment activities.
With the enactment of section 274, effective as of January
1, 1963, Congress narrowed the class of entertainment ex-
penses theretofore deductible under other provisions of the
Code and established strict substantiation requirements
with respect to entertainment expenses. Both parties have
submitted lengthy briefs cataloging the development of
section 274, and yet the substantive issue, as it has devel-
oped in this case, is largely a factual one.”
Respondent concedes that petitioner’s Ocracoke facility
was used primarily for the furtherance of petitioner’s busi-
ness but argues strenuously that neither the activity nor
facility expenditures were directly related to the active
‘*Section 274(b) provides in pertinent part as follow:
Sec. 274. DisALLOWANCE OF CERTAIN ENTERTAINMENT, Erc., Ex-
PENSES.
* * * a * * * & * ® *
(b) Gifts.—
(1) Limitation.—No deduction shall be allowed under sec-
tion 162 or section 212 for any expense for gifts made directly
or indirectly to any individual to the extent that such expense,
when added to prior expenses of the taxpayer for gifts made
to such individual during the same taxable year, exceeds
$25, * * *
See footnote 16, infra, for the text of Section 274(d).
12 The Congressional purpose and legislative history of section
274 have been examined in depth elsewhere, and we see no need
to reiterate them here. See, e.g., Dowell v. United States, 522 F. 2d
708 (5th Cir. 1975), certiorari denied 426 U.S. 920 (1976);
Hippodrome Oldsmobile, Inc. v. United States, 474 F. 2d 959 (6
Cir. 1973); St. Petersburg Bank & Trust Co. v. United States,
362 F. Supp. 674 (M.D. Fla., 1973), affd. 503 F. 2d 1402 (5 Cir.
1974), certiorari denied 423 U.S. 834 (1975).
19a
conduct of its business within the meaning of section 274
(a)(1)."* Although finding it “strange if business had not
been a topic of conversation,” respondent would have us
characterize the Ocracoke visits as goodwill-oriented pleas-
ure trips with business discussions arising only as a by-
product of bringing a group of businessmen together. The
record, however, does not support such an interpretation
with respect to the regularly conducted entertainment of
petitioner’s customer-guests. Rather, it clearly establishes
that substantial and bona fide business discussions directed
toward generation of income for petitioner arising from
transactions stemming therefrom were both the reason for
and result of these Ocracoke visits.
13 Sec. 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC.,
EXPENSES.
(a) Entertainment, Amusement, or Recreation.—
(1) In General.—No deduction otherwise allowable under this
chapter shall be allowed for any item—
(A) Activity.—with respect to an activity which is of a
type generally considered to constitute entertainment, amuse-
ment, or recreation, unless the taxpayer establishes that the
item was directly related to, or, in the case of an item directly
preceding or following a substantial and bona fide business
discussion (including business meetings at a convention or
otherwise), that such item was associated with, the active con-
duct of the taxpayer’s trade or business, or
(B) Facility—With respect to a facility used in connec-
tion with an activity referred to in subparagraph (A), unless
the taxpayer establishes that the facility was used primarily
for the furtherance of the taxpayer’s trade or business and
that the item was directly related to the active conduct of
such trade or business, and such deduction shall in no event
exceed the portion of such item directly related to, or, in the
case of an item described in subparagraph (A) directly pre-
ceding or following a substantial and bona fide business dis-
cussion (including business meetings at a convention or other-
wise), the portion of such item associated with the active
conduct of the taxpayer’s trade or business.
20a
Petitioner’s business of manufacturing machinery parts
for other companies did not lend itself to media marketing
but required personal contact between petitioner’s sales
representatives and employees of the companies to which
petitioner sold its products. Petitioner had an ongoing
business relationship with each of the customers it regu-
larly invited to hunting and fishing trips at Ocracoke. The
Ocracoke setting provided a congenial and relaxing atmos-
phere in which petitioner’s sales representatives had sev-
eral days of constant exposure to the individuals with
whom they did business and with whom they were able to
conduct the same types of business as when calling upon
them at their offices. The record is replete with examples of
specific projects that were the subject of business dis-
cussions held at Ocracoke. At times guests brought plans
and specifications for jobs to be discussed over the course
of an Ocracoke visit. By mixing the guests from several
customers, petitioner was able to stimulate sales by making
some companies aware of the work that it performed for
others—within the context of specific examples.
Respondent seeks to impugn the principal business char-
acter of all of petitioner’s Ocracoke entertainment by em-
phasizing the four uses of the facility identified on Table 4
and isolated bits of ambiguous testimony. The proper dis-
position with respect to the Table 4 uses, however, is dis-
allowance of deductions for the expenses incurred in con-
nection with these uses * and for the appropriate fractional
portion of the facility’s total operational expenses. Section
274(a)(1). Nor do we think that the testimony of John
William Gladstone, for example, justifies respondent’s
characterization of the Ocracoke entertainment. Gladstone
was a technical service superintendent for Albemarle
4 Petitioner’s records do not permit an allocation of expendi-
tures between Atkinson Dredging Co. and the North Carolina
legislators with respect to their joint use of the facility in 1967.
Consequently, the total expenditures as set forth in Table 4 must
be disallowed. Cf. sec. 1.274-5(c) (6) (ii), Income Tax Regs.
2la
Paper Company, whose responsibilities were product qual-
ity control and customer services. Albemarle used Berkley
products. Testifying in 1975, Gladstone indicated that he
visited petitioner’s Ocracoke facility on two occasions
“about ten or twelve years ago,” that he did not have
direct contact with petitioner in the normal course of busi-
ness, and although he realized that he was invited to Ocra-
coke because of his business position, that his primary
purpose in going was to enjoy himself. Table 1 shows that
in the period that Gladstone visited Ocracoke, petitioner
was just beginning to develop Albemarle as a customer.
We do not think it unreasonable that petitioner might ex-
pect an individual in Gladstone’s position to be one with
whom it would deal in attempting to sell its products. We
find it much more significant that Gladstone was not in-
vited back to Ocracoke in later years, alhough other Albe-
marle employees visited there even after the taxable years
here in issue. Moreover, Gladstone’s testimony indicates
that he was included in business discussions during the
visits that he made. That petitioner may have misjudged
at the outset of its relationship with Albemarle the extent
to which Gladstone would be involved does not alter our
conclusions about petitioner’s expectations and active pur-
suit of business during its Ocracoke entertainment. Like-
wise, the occasional presence of family members of peti-
tioner’s business guests does little to detract from the
strong showing of substantive business purpose of peti-
tioner’s Ocracoke entertainment.
Respondent’s reliance upon Handelman v. Commis-
sioner, 509 F. 2d 1067 (2 Cir. 1975), and Hippodrome Olds-
mobile, Inc. v. Unitted States, 474 F. 2d 959 (6 Cir. 1973),
is misplaced. Handelman involved expenses in connection
with a sailing sloop on which the taxpayer claimed to en-
tertain clients and potential clients in his law practice. The
principal holding there was that the taxpayer failed to
establish that the facility was used primarily for business
purposes—an issue conceded here by respondent. The court
22a
went on, however, “to conclude from this record that the
taxpayer scrupulously avoided any encroachment on the
glamorous atmosphere he wished to create so that he did
not conduct any business on the boat.” The record in this
case establishes, to the contrary, that petitioner’s cus-
tomer-guests often brought problems for discussion at
Ocracoke that had arisen after a trip was planned—com-
plete refutation that business was an encroachment upon
the atmosphere generated in the Ocracoke setting.
The fact that entertainees initiated some of the specific
discussions does not bring this case within the ambit of
Hippodrome Oldsmobile, Inc., however. In that case the
court of appeals held on the basis of a factual finding that
the taxpayer’s representative “would not initiate business
conversation” that entertainment expenses incurred under
such circumstances were not “directly related to * * * the
active conduct of the taxpayer’s * * * business.” This
case does not involve such a factual finding.
We do not doubt, as respondent argues, that petitioner
engendered the goodwill of its customers by maintenance
and use of its Ocracoke facility. Nevertheless, we are con-
vinced that the principal character of the combined en-
tertainment and business trips to Ocracoke was the active
conduct of petitioner’s Dysiness, to wit, to discuss business
problems and needs of its major customers and inform
them of the variety of functions that petitioner could per-
form within the context of specific jobs being done for
others. Consequently, deductions for the expenses attribu-
table to these uses are allowable under section 274(a) (1)
and sections 1.274-2(c)(3) and 1.274-2(d)(4), Income Tax
Regs."
1° Because we hold for petitioner on the substantive issue on the
basis of the directly related in general test described in sec. 1.274-2
(c)(3), Income Tax Regs., we do not elaborate on its questionable
but logically appealing argument that many of the expenditures
come within the business meal exception of section 274(e)(1) and
23a
The basic substantive issue having been resolved, we
must now consider whether petitioner has satisfied the
rigorous substantiation requirements of section 274(d)**
for the expenditures incurred in the active conduct of its
business. Pursuant to section 274(d), a taxpayer must es-
tablish five elements with respect to each entertainment
expenditure—amount, time, place, business purpose, and
business relationship. See sections 1.274-5(b)(3) and 1.274-
5(c), Income Tax Regs.
the corresponding regulations or its argument that Ocracoke con-
stituted a clear business setting within the meaning of sec. 1.274-2
(e)(4), Income Tax Regs. Nevertheless we have considered these
arguments sufficiently to determine that their applicability would
not alter the result we reach with respect to the expenditures on
which respondent’s determination is sustained.
16 Sec. 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC.,
EXPENSES.
«@ + we * * * * o * * *
(d) Substantiation Required.—No deduction shall be allowed—
(1) under section 162 or 212 for any traveling expense (in-
cluding meals and lodging while away from home),
(2) for any item with respect to an activity which is of a
type generally considered to constitute entertainment, amuse-
ment, or recreation, or with respect to a facility used in con-
nection with such an activity, or
(3) for any expense for gifts, unless the taxpayer substan-
tiates by adequate records or by sufficiént evidence corroborat-
ing his own statement (A) the amount of such expense or
other item, (B) the time and place of the travel, entertain-
ment, amusement, recreation, or use of the facility, or the
date and description of the gift, (C) the business purpose of
the expense or other item, and (D) the business relationship
to the taxpayer of persons entertained, using the facility, or
receiving the gift. The Secretary or his delegate may by regu-
lations provide that some or all of the requirements of the
preceding sentence shall not apply in the case of an expense
which does not exceed an amount prescribed pursuant to such
regulations.
24a
Petitioner did not maintain a separate diary or account
book for its Ocracoke expenditures; rather, they were
recorded in its cash journals and general expense ledgers
together with other business expenses. Petitioner did re-
tain, however, invoices, receipts, and petty cash records
which document each of the disputed expenditures recorded
in its promotional sales and Berkley Manor supplies ac-
counts. The petty cash records consisted of typed sum-
maries of disbursements, made periodically as the account
was replenished, and the appropriate supporting docu-
ments for those disbursements. The corporate books docu-
ment all of the expenses involved herein. Respondent does
not dispute the cost bases, useful lives, and salvage values
assigned by petitioner to the assets on which depreciation
was claimed, and he agrees that the amounts of expendi-
tures are substantiated and that the place of entertainment
was Ocracoke.
Respondent also agrees that the time of each expendi-
ture has been established, but he contends that the date
of pevment is insufficient to meet the requirement of sec-
tion 1.274-5(b) (3) (ii), Income Tax Regs., which refers to
“Date of entertainment.” Respondent argues that because
of the time lag between when entertainment occurred and
when bills were forwarded to and paid from petitioner’s
Norfolk office, it is impossible to reconstruct the dates of
trips without resorting to precisely the type of approxi-
mation that Congress intended to invalidate with the en-
actment of section 274(d). Respondent’s reasoning may be
correct, but it is based on an erroneous or inadequate view
of the evidence. Contained in the data supporting the cash
journal entries are numerous restaurant tickets which re-
flect dates that meals were taken. These tickets establish
with specificity when guests were on the island. Some of
the petty cash vouchers also refléct specific dates of the
trips to which the reimbursed expenditures relate. Starting
with the specific dates established by these documents, the
other bills, invoices, and receipts can be related to parti-
25a
cular dates of entertainment. This type of reconstruction is
exactly what has led to our entries on Tables 3 and 4, and
it establishes an accurate portrayal of the use of the Ocra-
coke facility.”
Disagreement over substantiation of the business rela-
tionship element revolves around respondent’s contention
that the name of each individual entertained at Ocracoke
must be identified and related to a particular visit and
specific expenditures in order to satisfy the statutory re-
quirement. Although many of the individual guests were
“lentified at trial, petitioner’s records permit only a de-
termination of which companies’ employees were present
at Ocracoke on a particular occasion. If respondent’s posi-
tion is correct, petitioner has failed to substantiate its
business relationship with its Ocracoke entertainees for
any use of the facility.
Respondent cites as authority for his view the follow-
ing language from Dowell v. United States, 522 F. 2d 708,
716 (5 Cir., 1975), certiorari denied 426 U.S. 920 (1976) :
The substantiation statute says “the”—not “a” busi-
ness relationship. And the business relationship can-
not be ascertained unless the taxpayer establishes the
‘7 In fairness to respondent, we should note that petitioner also
failed to emphasize with precision the evidence by which the dates
of entertainment are established. The chart appended to its initial
brief was deficient in several respects and properly criticized by
respondent. We think, however, that respondent has taken an en-
tirely too critical view of petitioner’s records as a whole. In his
criticism respondent ignores, for example, that each of the facility
uses set out in Table 4 is revealed in petitioner’s records; those
uses were not uncovered solely by third-party information, a factor
which might tend to render suspect all of the entertainment ex-
penses. We recognize that record-keeping in good form would do
much toward eliminating this kind of litigation, and petitioner's
records were not in good form, but we cannot and should not
ignore the substance of the evidence placed before us.
26a
identity of his entertainee—whether by name, title, or
other specific designation.
Although we think the plain language of the excerpt re-
futes respondent’s contention, when placed in context it
is clear that his interpretation is erroneous. The quoted
language was written in reference to expenses that were
not related to any particular entertainee. It is part of a
discussion by the court of monthly statements introduced
by the taxpayer without itemization of persons entertained,
dates of entertainment, amounts of particular expenditures,
and in some instances even the place of entertainment.
The court was discussing the business relationship element
in contradistinction to a showing of the business purpose of
the expenditures. The district court’s finding of business
purpose was upheld by the court of appeals, but it wished
to make clear that establishing the business purpose element
of substantiation is not tantamount to establishment of the
business relationship element—even concededly business
related entertainment expenses must be connected with
some particular entertainee, whether by name, title, or
other specific designation, in order to satisfy the require-
ment of section 274(d).
Similar analysis disposes of respondent’s reliance upon
Bradley v. Commissioner, 57 T.C. 1, 9 (1971). There, again,
one defect in the taxpayer’s evidence was his failure, with
one exception, to relate particular expenditures to any
person or persons entertained.
We cannot read either of those cases, or the language of
section 1.274-5(b)(3)(v), Income Tax Regs., to make the
names of individuals a mandatory requirement in estab-
lishing business relationship. That it is the substance of
the relationship and not the particular form of record-
keeping that substantiates business relationship, when ex-
penditures are connected with some entertainee, was made
clear by our recent decision in Rutz v. Commissioner, 66
27a
T.C. 879, 885 (1976). In Rutz we found contemporaneously
maintained records that contained only the names of in-
dividuals who were guests of the taxpayer inadequate to
substantiate business relationship.
In this case respondent does not dispute that petitioner
derived substantial income from the companies which em-
ployed the individuals entertained at Ocracoke (See Table
1). Petitioner’s records show the companies whose em-
ployees visited Ocracoke on particular occasions, and most
of the expenditures can be related to particular uses of the
facility. With respect to those expenses not capable of
being connected with a particular use of the facility, e.g.
foodstuffs placed in storage for use during several enter-
tainment periods, we think this a proper situation for
application of section 1.275-5(c)(4), Income Tax Regs.,
relating to substantiation in exceptional circumstances
where the taxpayer has presented the best evidence pos-
sible. In short, petitioner has substantiated its business
relatienship with the guests, and persons closely connected
to them, employed by the companies with whom it did
business. See Nicholls, North, Buse Co. v. Commissioner,
56 T.C, 1225, 1235-1236 (1971).
The business purpose of petitioner’s Ocracoke entertain-
ment has likewise been established. Both petitioner’s
employees and its business guests testified regarding the
nature of the business activity conducted at Ocracoke. Con-
trary to respondent’s characterization of their testimony
as vague and general, it provided in detail some of the
specific jobs or projects discussed during certain visits
to the island. Indeed, this evidence formed the basis for
our finding the Ocracoke expenditures incurred were di-
rectly related to the active conduct of petitioner’s business.
Again we emphasize the ongoing business relationship be-
tween petitioner and the company-employers of its busi-
ness guests, because that relationship set the tone for both
the business benefits petitioner expected to derive from
28a
its Ocracoke expenditures and the nature of the business
discussions engaged in there. The record does much more
than establish that petitioner’s guests were merely con-
nected in some way with the companies with which peti-
tioner did business. See Nicholls, North, Buse Co. v. Com-
missioner, supra, at 1236. Also significant is the total
absence of evidence of personal friendships between peti-
tioner’s stockholder-employees and its business entertainees
—a factor that has led this Court on many prior oc-
casions to seriously question the purported business pur-
pose of entertainment expenditures. See, e.g., Rute v.
Commissioner, supra, at 886; Sanford v. Commissioner,
supra, at 826-827.
During the taxable year 1967, petitioner purchased an
airplane at a cost of $86,487.90. On its income tax return
for that year, petitioner claimed an investment credit in
the amount of $6,054.14. Respondent disallowed both the
investment credit and the depreciation deduction claimed
with respect to the airplane based on his determination
that the airplane was to be used in connection with peti-
tioner’s Ocracoke entertainment.
Sections 38, 46, and 48 allow a credit against income tax
for depreciable personal property placed in service during
the taxable year. Section 1.46-3(d)(1), Income Tax Regs.,
provides that property will be considered as placed in
service the earlier of:
(i) The taxable year in which, under the taxpayer’s
depreciation practice, the period for depreciation with
respect to such property begins; and
(ii) the taxable year in which the property is placed
in a condition or state of readiness and availability
for a specifically assigned function, whether in a trade
or business, in the production of income, in a tax-
exempt activity, or in a personal activity.
29a
In view of our finding that the Ocracoke facility and ac-
tivities played an integral part in the active conduct of
petitioner's business, we think the airplane constituted a
depreciable asset placed in service in 1967 and the invest-
ment credit must be allowed.
Expenditures on Machinery
The last issue to be considered is whether certain ex-
penditures made by petitioner during 1965 and 1966 in
connection with equipment used in its machine shop and
foundry are currently deductible repairs expenses” or
capital expenditures subject to an allowance for deprecia-
tion.’®
18 Income Tax Regs.,
Sec. 1.162-4 Repairs—The cost of incidental repairs which
neither materially add to the value of the property nor appreciably
prolong its life, but keep it in an ordinarily efficient operating
condition, may be deducted as an expense, provided the cost of
acquisition or production or the gain or loss basis of the taxpayer’s
plant, equipment, or other property, as the case may be, is not
increased by the amount of such expenditures. Repairs in the
nature of replacements, to the extent that they arrest deteriora-
tion and appreciably prolong the life of the property, shall either
be capitalized and depreciated in accordance with section 167 or
charged against the depreciation reserve if such an account is kept.
1° Income Tax Regs.,
See. 1.263(a)-1 Capital expenditures ; in general.—
(a) Except as otherwise provided in chapter 1 of the Code, no
deduction shall be allowed for—
(1) Any amount paid out for new buildings or for perma-
nent improvements or betterments made to increase the value
of any property or estate, or
(2) Any amount expended in restoring property or in
making good the exhaustion thereof for which an allowance
is or has been made in the form of a deduction for deprecia-
tion, amortization, or depletion.
(b) In general, the amounts referred to in paragraph (a) of
this section include amounts paid or incurred (1) to add to the
30a
The test to be applied in distinguishing between the
two categories is “whether the expenditure materially en-
hances the value, use, life expectancy, strength, or ca-
pacity as compared with the status of the asset prior to
the condition necessitating the expenditure.” Plainfield
Union Water Co. v. Commissioner, 39 T.C. 333, 338 (1962).
But while the test may be simply stated, it draws a rather
shadowy line that makes it oftentimes difficult of applica-
bility. Nevertheless, exercising our best judgment on the
basis of the evidence placed before us, we have reached
the following conclusions.
With respect to the $7,906.88 of expenses incurred in
connection with the turret lathe in 1965, $736.29 was paid
to adapt the machine to a new and different use and there-
fore constitutes a capital expenditure. The remaining ex-
penditures were incurred to return the machine to the
degree of accuracy required in petitioner’s business, i.e.,
keep it in an ordinarily efficient operating condition. They
did not materially add to its value or appreciably prolong
its life, and they are currently deductible as ordinary and
necessary business expenses. Cf. Oberman Manufacturing
Co. v. Commissioner, 47 T.C. 471 (1967) (expenditure to
restore roof to pre-leakage condition, including some struc-
tural change, held repairs expense).
The expenditures of $13,661.84 in 1966 for a large num-
ber of parts for a wheelabrator machine were also, in our
opinion, ordinary and necessary business expenses. Ex-
penditures to replace worn-out parts of a large machine,
although capitalized originally as part of the cost of the
entire asset, are properly considered repairs expenses
value, or substantially prolong the useful life, of property owned
by the taxpayer, such as plant or equipment, or (2) to adapt
property to a new or different use. Amounts paid or incurred for
incidental repairs and maintenance of property are not capital
expenditures within the meaning of subparagraphs (1) and (2)
of this paragraph. See section 162 and § 1.162-4,
3la
when incurred to merely keep the machine in operating
condition. Libby ¢ Blouin, Lid. v. Commissioner, 4 B.T.A.
910 (1926).
With respect to the $6,826.00 of expenses incurred in
connection with petitioner’s lectromelt furnace, however,
we sustain respondent’s determination. The furnace shell,
costing $6,100.00, was a separate unit of the larger ma-
chine and itself had a useful life of about 20 years. There
was insufficient evidence adduced with respect to the
armature for us to decide on which side of the line it falls,
and, therefore, the presumption of correctness attached to
respondent’s determination must prevail.
Decisions will be
entered under Rule 155.
32a
APPENDIX B
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 78-1759
BerkLey Macuine Works & Founpry Company,
Appellees,
versus
CoMMISSIONER OF INTERNAL REVENUE,
Appellant.
Appeal from the United States Tax Court, at Washington. D.C.
J. Gregory Bruce, Judge.
Argued October 2, 1979.
Decided June 2, 1980.
Before Russett and Puiuurs, Cireuit Judges, and
Roszel C. THomsen, Senior United States District Judge,
sitting by designation.
Gilbert S. Rothenberg, Tax Division, Department of
Justice (M. Carr Ferguson, Assistant Attorney General,
Michael L. Paup and Gilbert E. Andrews, Tax Division,
Department of Justice on brief) for Appellant; Ellsworth
T. Simpson for Appellee.
Puiuures, Circuit Judge:
The Commissioner of Internal Revenue appeals from a
decision of the United States Tax Court, J. Gregory Bruce,
Judge, allowing the taxpayer a deduction of some $100,000
for business entertainment expenses incurred in connection
with a hunting and fishing facility it maintained on Ocra-
coke Island, North Carolina. Because we conclude that the
claimed expenses, while undoubtedly business-related, do
not meet the strict requirements of section 274 of the In-
33a
ternal Revenue Code of 1954 (as amended in 1962), and
that taxpayer has not adequately substantiated the ex-
penses as also required under that section, we reverse.
During the years at issue, 1963-67, taxpayer Berkley
Machine Works & Foundry Co. (Berkley) operated a
foundry, pattern shop and machine shop located in Norfolk,
Virginia. It manufactured machine parts used by other
companies in their production process. The company has
emphasized, with apparent success, its ability to produce
component or repair parts quickly and less expensively
than its competitors.
Media advertising is of limited usefulness in such a busi-
ness, and over the years Berkley has depended on per-
sonal contacts and maintenance of congenial working re-
lationships with its customers for the promotion of its
business. Berkley’s business during these years was con-
centrated in a small number of major customers. Its sales
representatives were each responsible for certain cus-
tomers on a continuous basis and were encouraged to get
acquainted with the employees with whom they would deal
in trying to fulfill a customer’s requirements.
One of the means developed by Berkley’s president,
Sam Jones, Sr. to develop and maintain good business
relations with its prime customers was the use of a hunt-
ing and fishing lodge owned and maintained by the com-
pany on Ocracoke Island, North Carolina. The island is
a 20-mile-long strip of land roughly mid-way of North
Carolina’s Outer Banks, with a small village at one end.
“Berkley Manor,” the company’s facility located there,
consists of three buildings, each containing a living room,
dining room and bedrooms. The largest building has a room
with a drafting board, table and chairs, which could be
used as a conference room.
On frequent weekends from early spring to late fall,
employees from Berkley’s major customers and some of
34a
its small ones were invited to Ocracoke for fishing week-
ends. The testimony indicated that Berkley’s officers would
decide which customer or customers would be invited for
a particular weekend, and the sales representative for that
customer would phone a contact of his in a position of
authority in that company, who would in turn designate
the employees allowed to go. Generally the parties were
composed of 15-20 people, frequently from one company
but sometimes from two or more different ones. It was
not unusual for the wives and children of employees to
accompany them (App. 340-41; 344-45). The responsible |
sales representative would attend, and Sam Jones was
usually present during the day, though he spent his nights
at his personal residence elsewhere on the island. Most
of the trips began on Thursday evening or Friday morn-
ing, and lasted through Sunday morning. The guests would
spend most of Friday and Saturday fishing on boats
chartetred by the company, each of which held four to six
people.
The testimony uniformly indicated that business dis-
cussions always took place on these trips, though not ac-
cording to any prearranged agenda. Witnesses for the
taxpayer, customer employees who had been present on
many of the fishing weekends, stated that business was a
subject that came up “anyplace, sometimes on the boat,
sometimes in the fishing lodge, sometimes in a room.”
(App. 157; 234). Another witness indicated that they would
“wind up talking shop” when “fishing was poor” and dis-
tractions were minimal. (App. 189-90). Sometimes the dis-
cussions centered on problems that had arisen in a cus-
tomer company’s production process, and a guest might
discuss with a Berkley representative whether certain re-
pair work could be performed or certain parts manufac-
tured. A few witnesses described occasions when they had
taken plans or specifications with them to Ocracoke to dis-
cuss whether Berkley could make the parts required. But
35a
no witness stated that the weekends were scheduled for
the purpose of resolving a particular problem; rather,
they took advantage of a previously planned fishing week-
end at Ocracoke to bring along business problems that had
arisen in the interim. (App. 186-87; 315). And Berkley’s
Vice ‘President, Sam Jones, Jr., could recall no Ocracoke
weekend when written contracts were actually negotiated.
(App. 264-65). Taxpayer claimed as business entertain-
ment expenses for the years 1963-67 various expenditures
made in providing these trips.
Ordinary and necessary business expenses of a taxpayer
are deductible under § 162 of the Internal Revenue Code.'
Business entertainment and travel expenses are governed
by this provision, but will be disallowed if they fail to
satisfy the more rigorous requirements of § 274(a)’ as
1 All Code references are to the Internal Revenue Code of 1954,
as amended.
? Sec. 274(a) provides in pertinent part:
§ 1.274 Statutory provisions; disallowance of certain enter-
tainment, ete., expenses.
Src, 274. Disallowance of certain entertainment, etc., ex-
penses—(a) Entertainment, amusement, or recreation—(1)
In general. No deduction otherwise allowable under this chap-
ter shall be allowed for any item—
(A) Activity. With respect to an activity which is of a
type generally considered to constitute entertainment, amuse-
ment, or recreation, unless the taxpayer establishes that the
item was directly related to, or, in the case of an item directly
preceding or following a substantial and bona fide business
discussion (including business meetings at a convention or
otherwise), that such item was associated with, the active
conduct of the taxpayer’s trade or business, or
(B) Facility. With respect to a facility used in connection
with an activity referred to in subparagraph (A), unless the
taxpayer establishes that the facility was used primarily for
the furtherance of the taxpayer’s trade or business and that
36a
well as the substantiation provisions of § 274(d). The Tax
Court found that Berkley’s Ocracoke-related expenditures
were sufficiently business-related to satisfy the require-
ments of § 162, and the record clearly supports that con-
clusion. The Government does not challenge this finding,
or the ruling that the Ocracoke lodge was used “primarily
for the furtherance of the taxpayer’s trade or business,”
as required by § 274(a)(1)(B). That provision simply re-
fines the principles of § 162, and may be satisfied if the
taxpayer establishes that more than 50 percent of the total
calendar days of use of the facility were devoted to busi-
ness use as defined by § 162, rather than to personal use.
Treas. Reg. § 1.274-2(e)(4) (1969); D.A. Foster Trench-
ing Co v. United States, 473 F.2d 1398, 1400-01 (Ct. Claims
1973).
The central issue on this appeal is whether the character
of the business activity at Ocracoke was such that the
entertainment deductions claimed with respect to it can be
said to have been “directly related to the active conduct”
of Berkley’s business, as further required by § 274(a) (1)
(B) (emphasis supplied). Additionally, even if that provi-
sion is satisfied, taxpayer must have produced adequate
substantiation for each item deducted, or the entire de-
duction must be disallowed under § 274(d). The Tax Court
concluded that the deductions were allowable under these
provisions, but we disagree.
the item was directly related to the active conduct of such
trade or business, and such deductions shall in no exent ex-
ceed the portion of such item directly related to, or, in the
case of an item described in subparagraph (A) directly pre-
ceding or following a substantial and bona fide business dis-
cussion (including business meetings at a convention or other-
wise), the portion of such item associated with, the active
conduct of the taxpayer’s trade or business.
37a
Proper application of § 274 requires a consideration of
the legislative history accompanying its passage. Support
for this section, added to the Code by the Revenue Act of
1962, was generated by a concern that the broad interpre-
tation given the “ordinary and necessary” language of
§ 162, together with the rule of Cohan v. Commissioner *
allowing deduction of an approximation of travel and
entertainment expenses, has led to widespread abuse of
the deduction provision. The substantiation requirements
of § 274(d) were intended to abolish the Cohan rule and
require the taxpayer to prove the exact amount and cir-
cumstance of the deduction; otherwise it would be dis-
allowed entirely.‘
Another evident purpose of section 274 was to limit the
types of business entertainment expenditures otherwise
deductible under § 162 by requiring them to meet a more
stringent standard of business-relatedness than had there-
tofore obtained. This purpose is clear in the House Ways
and Means Committee Report:
With respect to expenses for entertainment activi-
ties, the bill provides that a deduction will be allowed
only to the extent that the taxpayer establishes that
the expense was directly related to the active conduct
of his trade or business. This means that the taxpayer
must show a greater degree of proximate relation be-
tween the expenditure and his trade or business than
is required under present law. Among other things
he will have to show more than a general expectation
$39 F.2d 540 (2d Cir. 1930). The court there held that a tax-
payer who had incurred deductible travel or entertainment ex-
penses but could not prove their exact amount was entitled to a
deduction of an approximation of the amount.
* H.R. Rep. No. 1477, 87th Cong., 2d Sess. 19 (1962-3 Cum, Bull.
405, 427).
38a
of deriving some income at some indefinite future
time from the making of the entertainment-type ex-
penditure....°
This language reveals a clear intent by the House Com-
mittee to eliminate deductions for the expense of business
entertainment aimed at generating “good will” among
present or prospective customers, without necessarily in-
volving any concrete business ciscussions. Hippodrome
Oldsmobile, Inc. v. United States, 474 F.2d 959 (6th Cir.
1973). The Senate Finance Committee, however, felt the
House bill was too harsh on taxpayers and advocated an
amendment “to permit the deduction of expenses for
goodwill where a close association is established between
the expense and the active conduct of a trade or business.”
It proposed to add the language “or associated with” to
the “directly related to the active conduct of the taxpayer’s
trade or business” requirement in both subsections (A)
and (B) of section 274(a). The Senate Report stated:
“This new language will permit deduction of expenses for
entertainment, amusement, or recreation incurred for the
creation or maintenance of business goodwill without re-
gard to whether a particular exception applies.” °
The Joint Conference Committee Report reveals that a
compromise was reached whereby the Senate Committee
won on one issue with respect to § 274(a) and lost on the
other. The Conference Committee added the Senate lan-
guage to § 274(a)(1)(A) of the Act, disallowing deductions
with respect to an entertainment activity “unless the tax-
payer establishes that the item was directly related to, or,
in the case of an item directly preceding or following a
substantial and bona fide business discussion (including
business meetings at a convention or otherwise), that such
5 Id. at 18; 1962-3 Cum. Bull. at 424.
*S. Rep. No. 1881, 87th Cong., 2d Sess. 26, 27 (1962-3 Cum.
Bull. 707, 731-32).
39a
item was associated with” the active conduct of the tax-
payer’s trade or business.’ But the House Committee lan-
guage prevailed without addition of the “associated with”
qualifying language in § 274(a)(1)(B), concerning general
entertainment expenses in connection with facilities, which
is the section applicable to this appeal.
Treasury Regulations adopted pursuant to authority
granted in § 274(h) provide more insight into the mean-
ing of the “directly related” requirement. Section 1.274-2
(c)(3) provides:
(3) Directly related in general. Except as provided
in subparagraph (7) of this paragraph, an expendi-
ture for entertainment shall be considered directly re-
lated to the active conduct of the taxpayer’s trade or
business if it is established that it meets all of the
requirements of subdivisions (i), (ii), (iii) and (iv)
of this subparagraph.
(i) At the time the taxpayer made the entertain-
ment expenditure (or committed himself to make the
expenditure), the taxpayer had more than a general
expectation of deriving some income or other specific
trade or business benefit (other than the goodwill of
the person or persons entertained) at some indefinite
future time from the making of the expenditure. A
taxpayer, however, shall not be required to show that
income or other business benefit actually resulted
from each and every expenditure for which a deduc-
tion is claimed.
(ii) During the entertainment period to which the
expenditure related, the taxpayer actively engaged in
a business meeting, negotiation, discussion, or other
bona fide business transaction, other than entertain-
7H. Conf. Rep. No. 2508, 87th Cong., 2d Sess. 16 (1962-3 Cum.
Bull. 1129, 1143).
40a
ment, for the purpose of obtaining such income or
other specific trade or business benefit (or, at the time
the taxpayer made the expenditure or committee him-
self to the expenditure, it was reasonable for the tax-
payer to expect that he would have done so, although
such was not the case solely for reasons beyond the
taxpayer’s control).
(iii) In light of all the facts and circumstances of
the case, the principal character or aspect of the com-
bined business and entertainment to which the ex-
penditure related was the active conduct of the tax-
payer’s trade or business (or at the time the tax-
payer made the expenditure or committed himself to
the expenditure, it was reasonable for the taxpayer to
expect that the active conduct of trade or business
would have been the principal character or aspect of
the entertainment, although such was not the case
solely for reasons beyond the taxpayer’s control). It
is not necessary that more time be devoted to business
than to entertainment to meet this requirement. The
active conduct of trade or business is considered not
to be the principal character or aspect of combined
business and entertaimment activity on hunting or fish-
ing trips or on yachts and other pleasure boats unless
the taxpayer clearly establishes to the contrary.
(iv) The expenditure was allocable to the taxpayer
and a person or persons with whom the taxpayer en-
gaged in the active conduct of trade or business during
the entertainment or with whom the taxpayer estab-
lishes he would have engaged in such active conduct
of trade or business if it were not for circumstances
beyond the taxpayer’s control. For expenditures
closely connected with directly related entertainment,
see paragraph (d)(4) of this section.
26 C.F.R. § 1.274-2(c)(3) (emphasis supplied).
4la
Ill
We think it clear that the discussions that took place
during the Ocracoke weekends, while certainly business-
related and undoubtedly of general economic benefit to
Berkley, were not properly established on the evidence as
directly related to the active conduct of its business as
contemplated by the statutory language and history and
by the Regulations. Witnesses indicated that the trips were
valuable to both sides because they provided an opportunity
for the development of personal relationships between em-
ployees of customer companics and their contacts at Berk-
ley. This tended to smooth the way for a quick resolution
of problems that would arise in the course of the com-
panies’ business dealings. The practice of mixing employ-
ees from different companies on one trip allowed them to
compare notes on things that Berkley was doing for their
respective companies and may have, somewhere down the
road, generated more income for Berkley. Similarly, it may
have saved the company money when customers took ad-
vantage of their scheduled fishing weekend to bring up
problems that had recently surfaced in production sched-
ules or machine operation. None of this evidence, however,
indicates that Berkley had, at the time it arranged or took
part in the Ocracoke weekends, more than a “general
expectation of deriving some income or other specific trade
or business benefit,” other than goodwill, at some indefinite
future time.
Two customers did testify that they had on one or more
occasions brought plans or specifications along for the
purpose of going over specific projects with Berkley rep-
resentatives. Though this type of activity may constitute
a negotiation or discussion for the purpose of obtaining
a “specific trade or business benefit” under subparagraph
(3) (ii), these discussions were not adequately substanti-
ated under §274(d), as we discuss below. Because these
few specific discussions recalled by customers were inade-
42a
quately substantiated, and the discussions described in the
bulk of the trial testimony were informal and general in
nature, of the sort that inevitably arise when people whose
common bond is business are together, the taxpayer has
failed to overcome the presumption stated in subparagraph
(3) (iii), that the active conduct of trade or business is
considered not to be the principal character of combined
business and entertainment activity on hunting or fishing
trips, unless the taxpayer clearly establishes to the con-
trary. We think that Berkley’s evidence, consisting of un-
documented recollections by witnesses whose memories
were clouded by the passage of time so that most could
not positively recall even the year when these discussions
tuok place, cannot be considered to establish clearly that
the active conduct of business took place on all these oc-
casions. At most it reveals that the benefits derived by
Berkley from these weekends were in the area of general
business goodwill, exactly the type of expenditure that
Congress intended to eliminate as a deduction by means
of the directly related test.
Other courts have held that business entertainment pri-
marily directed toward generating goodwill cannot, as a
matter of law, be “directly related to the active conduct”
of the taxpayer’s business. Handelmann v. Commissioner,
509 F.2d 1067, 1074 (2d Cir. 1975); Hippodrome Olds-
mobile, Inc. v. United States, 474 F.2d 959, 960 (6th Cir.
1973); St. Petersburg Bank & Trust Co. v. United States,
362 F. Supp. 674 (M.D. Fla. 1973), aff’d, 503 F.2d 1402
(5th Cir. 1974). In Hippodrome, an automobile agency de-
ducted the expenses of a pleasure boat used for entertain-
ing past and prospective customers. The Sixth Circuit
reversed the district court’s holding that these expenses
met the requirement of sections 162 and 274 of the Code,
and held that these were goodwill expenditures clearly
disallowed by the directly related test. 474 F.2d at 960.
The Handelmann court also reversed the Tax Court’s
allowance of deductions by an attorney of expenses con-
43a
nected with entertainment of clients, past and future, on
his yacht, for promotional purposes. The Tax Court in
the instant case held these cases inapposite because of
factual distinctions, particularly that the taxpayers in both
cases generally would not initiate business discussions on
the boat trips. Though we recognize the difference between
the type of entertainment and the atmosphere in these
cases and that provided by Berkley, we do not think they
are so significant as to remove the Ocracoke weekends
from the same category of goodwill entertainment. Prob-
ably the Berkley representatives did at times initiate busi-
ness discussions (though the testimony concerning such
discussions as did take place indicates that they were
initiated by the customer) but we do not think that this
point is dispositive. The Hippodrome court noted that fact
only in ruling on the narrow point that the taxpayer had
not met the requirement of 26 C.F.R. § 1.274-2(c) (3) (ii),
by showing that it had actively engaged in bona fide busi-
ness transactions during the excursions. 474 F.2d at 965.
Nor was this point crucial to the Handelmann holding
that the taxpayer had not shown more than a general ex-
pectation of deriving income at some indefinite future time
from his entertainment expenditures. 509 F.2d at 1074.
The Treasury Regulations in this area clearly intend that
all the facts and circumstances of each case must be con-
sidered in determining the character of the business con-
duct. Though the business discussions at Ocracoke, among
businessmen with an ongoing relationship, may have been
more concrete than those indicated by the facts in Hippo-
drome and Handelmann, there are other considerations,
such as the larger number of people, some of whom were
not business associates, and the variety of pleasurable dis-
tractions, that point to the essentially indirect relationship
between these outings and the active conduct of taxpayer’s
business. These factors were significant in the St. Peters-
burg Bank case, in which the bank had a practice of invit-
ing present or potential customers to dove shoots and
44a
barbecues, during which bank employees would circulate
among the guests and tout the services of the bank, some-
times discussing specific transactions. 362 F. Supp. at
675. The court nevertheless found that the benefits to the
bank were of the goodwill variety and the entertainment
did not pass the “directly related” test. Id. at 680.°
IV
Having determined that the entertainment expenditures
related to the operating costs of the Ocracoke facility are
not “directly related” expenditures within the meaning of
§ 274(a)(1)(B), it is appropriate to consider whether cer-
®’None of the other subparagraphs of the Regulation section
defining ‘‘directly related’’ entertainment is helpful to this tax-
payer. The Ocracoke expenditures were not made in a ‘‘clear
business setting’’ within the meaning of § 1.274-2(c) (4) ; this pro-
vision applies to entertainment that is clearly subordinete to a
business purpose, such as the operation of a hospitality roo: at
a convention. Subparagraph (7) supports this conclusion by pro-
viding that certain expenditures are generally considered not di-
rectly related, including those where ‘‘[t|he distractions were
substantial, such as ... (b) A meeting or discussion, if the tax-
payer meets with a group which includes persons other than busi-
ness associates, at places such as cocktail lounges, country clubs,
golf and athletic clubs, or at vacation resorts.’’ This provision
tracks the Conference Committee Report, which noted that the
rule of the House bill, which prevailed in this section, ‘‘would
not allow deduction of expenditures for entertainment occurring
under circumstances where there is little or no possibility of con-
ducting business affairs or carrying on negotiations or discussions
relating thereto, such as where the group of persons entertained
is large or the distractions substantial.’’ H. Conf. Rep. No. 2508,
87th Cong., 2d Sess. 16 (1962-3 Cum. Bull. 1129, 1143), Clearly
the Ocracoke weekends, involving fairly large groups of people,
some of whom were not business associates, and taking place in a
setting where the distractions for sportsmen were substantial, were
not the ‘‘clear business setting’’ envisioned by Congress. See. D. A.
Foster Trenching Co. v. United States, 473 F.2d 1398, 1402-04
(Ct. Cl. 1973).
45a
tain categories of the Ocracoke expenditures are neverthe-
less allowable under § 274(a)(1)(A), relating to activities.
Section 1.274-2(e) (3) (iii) (a) of the Regulations provides
that certain “out of pocket” expenditures, such as those
for food and beverages, are not to be considered as ex-
penditures with respect to a facility, under subsection (B.
But the question arises whether these expenses may be
allowed as deductions under the more lenient “associated
with” test of subsection (A), which as the legislative his-
tory reveals, was intended to include goodwill entertain-
ment. This test is expressly qualified, however, by the lan-
guage that the expense must relate to “an item directly
preceding or following a substantial and bona fide business
discussion (including business meetings at a convention or
otherwise) ....” The Conference Committee Report that
discussed the addition of this language notes as examples
of expenses that qualify under this section, the entertain-
ment of a group of business associates at a restaurant,
theater or sporting event following substantial negotia-
tions, or the entertainment of out-of-town business associ-
ates on the evening before such “substantial business dis-
cussions.” H. Conf. Rep. No. 2508, 87th Cong., 2d Sess. 17.
The Ocracoke weekends clearly do not come within the
statute’s contemplation of entertainment that takes place
purely as an adjunct to formal business meetings. Nor do
we consider that expenses may qualify under the test
when the claimed business discussions take place during
the course of a combined social/business function. See St.
Petersburg Bank & Trust Co. v. United States, 362 F. Supp.
674, 681 (M.D. Fla. 1973). Thus Berkley’s Ocracoke-related
expenditures must be considered disallowed under both
subsections (A) and (B) of § 274(a)(1).
Vv
Having concluded that Berkley’s contested entertainment
deductions must be disallowed under § 274(a), it may not
46a
be strictly necessary to consider separately the Govern-
ment’s argument that the deductions must be disallowed
for lack of adequate substantiation under § 274(d). But
because we should correct the misapprehension of the Tax
Court concerning these substantiation requirements, and
because a few of Berkley’s witnesses testified to business
discussions that might have passed the directly related
test had they been adequately substantiated, we also ad-
dress this point.
Section 274(d) of the Code disallows business entertain-
ment expenses altogether “unless the taxpayer substanti-
ates by adequate records or by sufficient evidence corrob-
orating his own statement (A) the amount of such ex-
pense ..., (B) the time and place of the... entertainment
. , (C) the business purpose of the expense... , and
(D) the business relationship to the taxpayer of persons
entertained ....”’ The Treasury Regulations relating to
this section state that “adequate records” are an account
book, diary, statement of expense or similar record...
and documentary evidence ... which, in combination, are
sufficient to establish each element of an expenditure... .”
§ 1.274-5(¢c) (2). Alternatively, if the taxpayer fails to meet
the adequate records requirement, he must establish each
element “[b]y his own statement, whether written or oral,
containing specific information in detail as to such ele-
ment; and (ii) By other corroborative evidence sufficient
to establish such element.” § 1-274-5(c) (3). These Regula-
tions have been held lawful and obedient to the legislative
intent of § 274, and applied in Dowell v. United States, 522
F.2d 708, 713 (5th Cir. 1975); Nicholls, North, Buse Co.
v. Commissioner, 56 T.C. 1225, 1234 (1971); Sanford v.
Commissioner, 50 T.C. 823, 830-32 (1968) ; aff’d per curiam,
412 F.2d 201 (2d Cir. 1969).
The statute and the Regulations place a heavy burden
on the taxpayer, to substantiate each element of every
deducted item of entertainment expense. Dowell, 572 F.2d
47a
at 714; BJR Corp. v. Commissioner, 67 T.C. 111, 128
(1976); Fiorentino v. Commissioner, PH Memo T.C., par.
70,316, p. 1583 (1970). This burden was thought to be justi-
fied, however, by the abuses of the business entertainment
deduction know to be practiced under the old loose stand-
ards of § 162 and the Cohan rule. The requirement of sub-
stantiation allows the Government to double-check the
amount and the true business character of the deduction,
instead of being forced to rely on the taxpayer’s “own
unsupported, selfserving testimony.” (S. Rep. No. 1881,
87th Cong., 2d Sess. 37).
Berkley presented what the Tax Court found were ade-
quate records of the place, time, and amount of the con-
tested expenditures, and the Government does not chal-
lenge the court’s findings as to these elements. It does con-
test Berkley’s substantiation of the business purpose of
the trips and the business relationship of the guests. The
company kept no written diary of the Ocracoke trips de-
scribing the business purpose for each, and so had to rely
on the testimony of some of its guests to corroborate its
own statement that the trips had a business purpose. The
taxpayer’s own statement, as contained in the testimony of
its officers, does not provide the “specific information in
detail” required by the Regulations; moreover, the cor-
roborative testimony consisted of testimony by only nine
of some 1,000 guests during the relevant years, their testi-
mony related to only 12 of 76 trips, and they could not
relate specific business discussions to specific trips. The
Tax Court considered this testimony sufficient to establish
business purpose in light of the absence of any evidence
of personal, non-business use of the facility. But we are
of the opinion that this sort of general, often conjectural
testimony as to business purpose is exactly the sort of
unreliable recollection that the substantiation require-
ments of § 274(d) were designed to foreclose. See Rutz v.
Commissioner, 66 T.C. 879, 883-84 (1976); Nicholls, North
48a
Buse Co. v. Commissioner, 56 T.C. 1225, 1235 (1971). The
Regulations do allow the corroborative evidence of busi-
ness purpose to be circumstantial in nature, § 1-274-5(c)
(3) (ii); but we do not think that evidence of the nature of
the Ocracoke trips in general will support a conclusion
that each trip had a business purpose. Cf. Dowell v. United
States, 522 F.2d at 714.
We also conclude that the Tax Court erred in holding
that Berkley had adequately substantiated the business re-
lationship of each entertainee at Ocracoke. As the court
found, though the taxpayer’s witnesses recalled the names
of some individual guests, its records contain only a nota-
tion of the company whose employees were invited down
on a particular weekend. To permit the business relation-
ship element to be established by this kind of evidence,
when guests had no business relationship with Berkley
admittedly attended in response to the corporate invita-
tion, would frustrate the purpose of this element of sub-
stantiation, intended to prevent deductions for “business-
related” entertainment of persons actually having no busi-
ness relation to the taxpayer. The Tax Court is not in-
correct in its conclusion that “it is the substance of the
relationship and not the particular form of record-keeping
that substantiates business relationship”; but the required
“substance” must be clear from the records if a taxpayer
is to get the deduction. A business relationship must be
established by identification of each person involved in
the entertainment deduction, 26 C.F.R. § 1.274-5(b) (1) (iv) ;
if the relationship is, as was the case in Rutz v. Commis-
stoner, 66 T.C. 879 (1976), not clear from the name, then
the job title should be noted as well. Contrary to the Tax
Court’s reading, we find Dowell v. United States in sup-
port of this interpretation. Though Dowell’s records were
inadequate in areas other than the business relationship
element, the court’s view of the business relationship ele-
ment was clearly stated: “the business relationship cannot
49a
be ascertained unless the taxpayer establishes the identity
of his entertainee—whether by name, title or other specific
designation,” 522 F.2d at 716. Though on first reading
Nicholls, North, Buse Co. v. Commissioner, 56 T.C, 1225
(1971) seems to indicate that a record of the employer
companies would be sufficient to establish business relation-
ship, a closer reading reveals that this was not the ruling
of the court. The taxpayer there kept a log in which he
wrote the names of the individuals entertained on his
boat, sometimes noting the name of their employer as well.
Id. at 1232. The court simply noted that business relation-
ship arguably might have been proved if the employers
of all the guests had been listed in the log. 7d. at 1235.
Thus it was the employer’s name in addition to, not instead
of, the individual’s name, that would have substantiated
their business relationship. Certainly a notation of the
employer of the individuals entertained by a taxpayer is
helpful in establishing the business relationship of the
entertainee; but it is not sufficient without some further
identification of the individuals themselves. We conclude
that Berkley failed to substantiate adequately the business
purpose of the Ocracoke trips and the business relationship
of its guests; thus the Ocracoke-related deductions must
be disallowed under § 274(d) as well as under § 274(a).
VI
One final issue remains for resolution. Included in the
total depreciation deduction claimed by Berkley for 1967
is $1,441.46 for an airplane purchased in that year for
$86,487.90. The Commissioner disallowed this deduction,
as well as an investment credit of $6,054.14 claimed with
respect to the airplane, based on his assumption that the
airplane was purchased for use in connection with tax-
payer’s Ocracoke entertainment activities. The Tax Court,
having found the Ocracoke activities directly related to the
active conduct of taxpayer’s business, allowed the deduc-
50a
tion. Other than the testimony of Berkley’s accountant that
the plane was kept at Norfolk, Virginia and was listed with
the Ocracoke assets on Berkley’s tax return because there
happened to be room for it on that page, there is no evi-
dence in the record as to how the airplane was used. We
think the airplane cannot qualify for the investment credit
or depreciation deductions because the taxpayer has made
no showing that the plane was used in its trade or business
or held for the production of income. Internal Revenue
Code, §§ 167, 38.
REVERSED.
Russe.u, Circuit Judge, dissenting:
I dissent for the reasons by the Tax Court, which I think
correctly construed the law and the facts herein.
5la
APPENDIX C
Internal Revenue Code, 1954
Sec. 162 Trade or Business Expenses.
(a) In General.—There shall be allowed as a deduction
all the ordinary and necessary expenses paid or incurred
during the taxable year in carrying on any trade or busi-
ness, including—
Sec. 274 Disallowance of Certain Entertainment, Expenses.
(a) Entertainment, Amusement, or Recreation.—
(1) In general.—No deduction otherwise allowable
under this chapter shall be allowed for any item—
(A) Activity—With respect to an activity which
is of a type generally considered to constitute en-
tertainment, amusement, or recreation, unless the
taxpayer establishes that the item was directly
related to, or, in the case of an item directly pre-
ceding or following a substantial and bona fide
business discussion (including business meetings
at a convention or otherwise), that such item was
associated with, the active conduct of the tax-
payer’s trade or business, or
(B) Facility—With respect to a facility used in
connection with an activity referred to in subpara-
graph (A), unless the taxpayer establishes that
the facility was used primarily for the further-
ance of the taxpayer’s trade or business and that
the item was directly related to the active con-
duct of such trade or business,
and such deduction shall in no event exceed the portion
of such item directly related to, or, in the case of an
item described in subparagraph (A) directly preced-
52a
ing or following a substantial and bona fide business
discussion (including business meetings at a conven-
tion or otherwise), the portion of such item associated
with, the active conduct of the taxpayer’s trade or
business.
(2) Special rules.—For purposes of applying para-
graph (1)—
(d) Substantiation Required.—No deduction shall be
allowed—
(1) under section 162 or 212 for any traveling ex-
pense (including meals and lodging while away from
home),
(2) for any item with repect to an activity which is
of a type generally considered to constitute entertain-
ment, amusement, or recreation, or with respect to a
facility used in connection with such an activity, or
(3) for any expense for gifts,
unless the taxpayer substantiates by adequate records or
by sufficient evidence corroborating his own statement (A)
the amount of such expense or other item, (B) the time and
place of the travel, entertainment, amusement, recreation
or use of the facility, or the date and description of the
gift, (C) the business purpose of the expense or other
item, and (D) the business relationship to the taxpayer of
persons entertained, using the facility, or receiving the
gift. The Secretary may by regulations provide that some
or all of the requirements of the preceding sentence shall
not apply in the case of an expense which does not exceed
an amount prescribed pursuant to such regulations.
53a
Treasury Regulations
Treas. Reg. 1.274-2(c)(3)
(3) Directly related in general. Except as provided in
subparagraph (7) of this paragraph, an expenditure for
entertainment shall be considered directly related to the
active conduct of the taxpayer’s trade or business if it is
established that it meets all of the requirements of subdi-
visions (i), (ii), (iii) and (iv) of this subparagraph.
(i) At the time the taxpayer made the entertainment
expenditure (or committed himself to make the expendi-
ture), the taxpayer had more than a general expectation
of deriving some income or other specific trade or business
benefit (other than the goodwill of the person or persons
entertained) at some indefinite future time from the mak-
ing of the expenditure. A taxpayer, however, shall not be
required to show that income or other business benefit
actually resulted from each and every expenditure for
which a deduction is claimed. (Emphasis added)
(ii) During the entertainment period to which the ex-
penditure related, the taxpayer actively engaged in a busi-
ness meeting, negotiation, discussion; or other bona fide
business transaction, other than entertainment, for the
purpose of obtaining such income or other specific trade
or business benefit (or, at the time the taxpayer made the
expenditure or committed himself to the expenditure, it
was reasonable for the taxpayer to expect that he would
have done so, although such was not the case solely for
reasons beyond the taxpayer’s control).
(iii) In light of all the facts and circumstances of the
case, the principal character or aspect of the combined
business and entertainment to which the expenditure re-
lated was the active conduct of the taxpayer’s trade or
business (or at the time the taxpayer made the expendi-
ture or committed himself to the expenditure, it was rea-
sonable for the taxpayer to expect that the active conduct
54a
of trade or business would have been the principal char-
acter or aspect of the entertainment, although such was not
the case solely for reasons beyond the taxpayer’s control).
It is not necessary that more time be devoted to business
than to entertainment to meet this requirement. The active
conduct of trade or business is considered not to be the
principal character or aspect of combined business and
entertainment activity on hunting or fishing trips or on
yachts and other pleasure boats unless the taxpayer clearly
establishes to the contrary. (Emphasis added)
(iv) The expenditure was allocable to the taxpayer and
a person or persons with whom the taxpayer engaged in
the active conduct of trade or business during the enter-
tainment or with whom the taxpayer establishes he would
have engaged in such active conduct of trade or business
if it were not for circumstances beyond the taxpayer’s con-
trol. For expenditures closely connected with directly re-
lated entertainment, see paragraph (d)(4) of this section.
(4) Determination of primary use—
(i) In general. A facility used in connection with enter-
tainment shall be considered as used primarily for the
furtherance of the taxpayer's trade or business only if it
is established that the primary use of the facility during
the taxable year was for purposes considered ordinary and
necessary within the meaning of sections 162 and 212 and
the regulations thereunder. All of the facts and circum-
stances of each case shall be considered in determining
the primary use of a facility. Generally, it is the actual
use of the facility which establishes the deductibility of
expenditures with respect to the facility ; not its availability
for use and not the taxpayer’s principal purpose in acquir-
ing the facility. Objective rather than subjective standards
will be determinative. If membership entitles the member’s
entire family to use of a facility, such as a country club,
their use will be considered in determining whether busi-
ness use of the facility exceeds personal use. The factors
55a
to be considered include the nature of each use, the fre-
quency and duration of use for business purposes as com-
pared with other purposes, and the amount of expenditures
incurred during use for business compared with amount of
expenditures incurred during use for other purposes. No
single star ‘ard of comparison, or quantitative measure-
ment, as to the significance of any such factor, however, is
necessarily appropriate for all classes or types of facili-
ties. For example, an appropriate standard for determining
the primary use of a country club during a taxable year
will not necessarily be appropriate for determining the
primary use of an airplane. However, a taxpayer shall be
deemed to have established that a facility was used pri-
marily for the furtherance of his trade or business if he
establishes such primary use in accordance with subdi-
vision (ii) or (iii) of this subparagraph. Subdivisions (ii)
and (iii) of this subparagraph shall not preclude a tax-
payer from otherwise establishing the primary use of a
facility under the general provisions of this subdivision.
(iii) Entertainment facilities in general. A taxpayer
shall be deemed to have established that—
(a) A facility used in connection with entertainment,
such as a yacht or other pleasure boat, hunting lodge, fish-
ing camp, summer home or vacation cottage, hotel suite,
country club, golf club or similar social, athletic, or sport-
ing club or organization, bowling alley, tennis court, or
swimming pool, or,
(b) A facility for employees not falling within the scope
of section 274(e)(2) or (5)
was used primarily for the furtherance of his trade or
business if he establishes that more than 50 percent of the
total calendar days of use of the facility by, or under
authority of, the taxpayer during the taxable year were
days of business use. Any use of a facility (of a type de-
56a
scribed in this subdivision) during one calendar day shall
be considered to constitute a “day of business use” if the
primary use of the facility on such day was ordinary and
necessary within the meaning of section 162 or 212 and the
regulations thereunder. For the purposes of this subdivi-
sion, a facility shall be deemed to have been primarily used
for such purposes on any one calendar day if the facility
was used for the conduct of a substantial and bona fide
business discussion (as defined in paragraph (d) (3) (i)
of this section) notwithstanding that the facility may also
have been used on the same day for personal or familly use
by the taxpayer or any member of the taxpayer’s family
not involving entertainment of others by, or under the
authority of, the taxpayer. (Emphasis added)
(iv) Business purpose. Business reason fcr the enter-
tainment or nature of business benefit derived or expected
to be derived as a result of the entertainment and, except
in the case of business meals described in section 274(e)
(1), the nature of any business discussion or activity;
(v) Business relationship. Occupation or other informa-
tion relating to the person or persons entertained, includ-
ing’ name, title, or other designation, sufficient to establish
business relationship to the taxpayer. (Emphasis added)
(4) Expenditures in clear business setting. An expendi-
ture for entertainment shall be considered directly related
to the active conduct of the taxpayer’s trade or business if
it is established that the expenditure was for entertainment
occurring in a clear business setting directly in further-
ance of the taxpayer’s trade or business... .
Treas. Reg. § 1.274-5
(b) Elements of an expenditure—(1) In General. Sec-
tion 274(d) and this section contemplate that no deduction
shall be allowed for any expenditure for travel, entertain-
ment, or a gift unless the taxpayer substantiates the follow-
ing elements for each such expenditure:
57a
(i) Amount;
(ii) Time and place of travel or entertainment (or use
of a facility with respect to entertainment), or date and
description of a gift;
(iii) Business purpose; and
(iv) Business relationship to the taxpayer of each per-
son entertained, using an entertainment facility or receiv-
ing a gift.
Federal Rules of Civil Procedure—Rule 52(a)
(a) Errecr.
... Findings of fact shall not be set aside unless clearly
erroneous, and due regard shall ke given to the opportunity
of the trial court to judge of the credibility of the wit-
nesses.
58a
(R. 154-156)
Direct Testimony of :
Martin Ellers, Vice-President-General Manager, Drill
Carrier Corporation.
Q. * * *, calling your attention to the years 1963 to 1967,
were you employed during that period of time?
A. I was employed by the Drill Carrier Corporation,
Salem, Virginia.
A. I was Vice President and General Manager.
Q. * * *, directing your attention to the year 1963, did
you visit Ocracoke Island, North Carolina, as a guest of
Berkley Machine Works?
A. Yes.
. Was this also true in the years 1964, 1965, and 1966?
A. Yes.
Q. * * * On these occasions that you were present down
on Ocracoke Island as a guest of Berkley Machine Works,
were you one of several other guests who went on fishing
trips together?
A. Yes.
Q. * * * on occasions that you were a guest of Berkley
down on Ocracoke, were there other employees of Drill
Carrier also guests at that time?
A. There were.
Q. Can you now recall the names of some of those people
who were guests?
A. George Sheppe, John Wood, Bill Goodwin, Car] Kirk-
john, George Temple, George Frye.
59a
(R. 194-195)
Direct Testimony of :
Andrew Scott, Official, American Oi] Company.
Q. * “ * directing your attention to the year 1963, did
you visit Ocracoke Island, North Carolina, as a guest of
Berkley Machine Works, * * *?
I did.
Were you a guest down there in the year 1964?
I was.
And were you a guest down there in 1965?
Yes, sir.
1966?
Right.
1977?
Yes, sir.
. So you had been there every year from 1963 through
1967, is that correct?
A. That’s correct.
Q. On those occasions when you were there, were you
one of several other guests who went on fishing trips?
A. I was.
(). * * * On those occasions when you were down as a
guest, were there other employees of the American Oil
Company who were also guests on those occasions?
A. Yes.
(). If you can, tell us their names, * *
A. I ean tell you some: Mark Hopkins, Jack Webb, Ce-
cil Ileath, Buddy Wakefield; there are at least six or eiglit
more but right off-hand I can’t call.
Q. While you were down there were there * * * other
guests from companies other than American Oil Company
x“ * & ?
A. Yes.
(). Can you recall at the present time who some of those
people were?
A. Well, on some occasions there were people there from
Union Bag and Camp; there were people there from Ply-
~*,
O>Orearere>
60a
moutli, North Carolina; there were people there from Car-
rier Corporation. I think at one time or another there were
people there from most everyone who had been to Ocracoke
and on the. fishing parties that I was on.
Q. Can you recall some of the names of the individuals
of these other companies that were with you or down at the
same time you were there?
A. The companies or the names?
(). The names of the individuals.
A. Slim Eubanks, Jerry Polk, a fellow we called Big
John from over at Union Bag and Camp—I don’t recall
his last name—a fellow by the name of Duck from Union
Bag and Camp.
(R.217-219)
Direct Testimony of:
John Lee Wood, Mechanical Engineer, Drill Carrier
Corporation.
(). * * * Mr. Wood, what is your present occupation or
employment?
A. I’m a mechanical engineer. I work for the Gardner
Denver Company which has recently acquired the old Drill
Carrier Corporation.
7 * o * & * om * * *
(. Now, directing your attention to the year 1963, did
you visit Ocracoke Island, North Carolina, as a guest of
Berkley?
I believe so.
Would that be also in 1964?
That’s right.
Is that also true in 1965?
Yes, sir.
. Did you visit Ocracoke as a guest in 1966, if you
recall?
A. Yes, I believe so.
erere>r
6la
(). On those occasions, were you one of several other
guests who went on fishing trips together on Ocracoke? |
A. Yes, sir.
Q. Now, on the occasions that you were a guest, were
there other employees of the Drill Carrier Corporation
who were also guests of Berkley on Ocracoke Island?
A. Yes, sir.
Q. * * *, if you can recall, tell the Court their names.
A. There was Martin Ellers; there was George Sheppe;
Bill Goodman; Carl Kirbjun; Bud Day, I believe, was down
there; there was several people from the Gardner Denver
Company, our present owner, that went down there at that
time. One was vice president of the Company, Don Kipley.
I might correct myself—Georze Day or Bud Day is a dis-
_ tributor of our product. He was with Air Service in At-
lanta, Georgia. We had Frank Houchens. I think Mr.
Bolayer went one time.
Q. Now, while you were a guest of Berkley do you know
whether or not there was employees of other customers
of Berkley Machine Works who were also guests at that
time?
A. I think on occasion I might have met one or two down
there from Union Bag.
Q. Can you recall the names of those two?
A. Well, one in particular is going to be a witness here
this morning, Mr. Eubanks.
(R.231-233)
Direct Testimony of:
George B. Sheppe, Finance Manager, Drill Carrier
Corporation.
A. Mr. Sheppe, what is your present occupation or em-
ployment?
Q. My present occupation is Manager of Finance and
Personnel for Gardner Denver Company, Drill Carrier
Division.
62a
Tue Courr: And Drill Carrier is now called a division
of what’s the other-——
Tue Witness: Gardner Denver Company.
Q. * * *, directing your attention to the year 1963, did
you visit Ocracoke Island, North Carolina, as a guest of
Berkley Machine Works and Foundry Company?
A. Yes, I did.
Q. * * * did you visit Ocracoke as a guest in 1964?
A. Yes, I did.
Q. In 1965.
A. Yes, I did.
Q. In 1966 did you also visit Ocracoke as a guest of
Berkley Machine Works?
A. Yes, sir.
(). On those occasions were you one of several other
guests who went on fishing trips together?
A. That’s true. Yes, sir.
Q. * * * if you can recall, who these other employees
were who were at the Ocracoke facilities at the time you
were?
A. I can recall a Mr. Martin Ellers who was my boss,
John Wood, Carl Kirbjun, Bill Goodwin, Jim Marshall.
(R. 268-269)
Direct Testimony of:
Harvey J. Hubbard, Purchasing Manager, Union Camp
Paper Products Company
Q. Directing your attention to the year 1964, did you
visit Ocracoke Island, North Carolina, as a guest of Berk-
ley Machine Works and Foundry Company?
A. I would think so. I don’t recall exactly the years. I’ve
been a guest at Ocracoke most every year since 1962. Only
one or two years I have not been a guest, this being one
year of that time, so I feel that I’m correct in saying that
I was the guest of Berkley at Ocracoke at that year.
63a
Q. And would that also be true, Mr. Hubbard, with re-
spect to the years 1965, ’66 and ’67?
A. Yes, sir. It would.
Q. * * * on those occasions that you were a guest of
Berkley Machine Works at Ocracoke Island, were there
other guests of Berkley’s who were employees of Union
Bag Camp together on those trips with you?
A. Oh yes. Yes, sir.
Q. * * * if you can, * * * tell us who they were.
A. Well, on each of the trips I’ve been a guest there we
had representatives from our engineering, our mainte-
nance, the manufacturing departments. Normally, they’re
the department heads or their assistants, so this would be
Mr. Ed Rogers, some of his young engineers, such as Jack
Harold.
A. Slim Eubanks, S. E. Eubanks, Mr. W. T. Dougherty,
Mr. J. J. Yirack. Normally there were 14 to 16 of us on
each of those occasions and all of them were supervisors
of the mill in the various departments that I mentioned.
(R. 288, 290)
Direct Testimony of:
Sam E. Eubanks, Master Mechanic, Union Camp Paper
Products.
(). Mr. Kubanks, what is your present occupation or
employment?
A. Master mechanic, and that is in charge of mechanical
maintenance, at Union Camp.
Q. Directing your attention to the year 1963, did you
visit Ocracoke Island, North Carolina as a guest of Berk-
ley Machine Works & Foundry Company?
A. * * * I don’t have records, but I’m sure I did. Yes, sir.
64a
Q. Would that also be true in 1964?
A. Well, later ’64 or early °65 I had a severe heart attack
and I think I did go in ’64, and it was possible that I didn’t
go in ’64 or ’65, and I can’t recall which year it was for sure.
Q. Were you down there as a guest in 1966?
A. I think so, Yes, sir.
Q. * * * on those occasions that you were a guest * * *
were there other employees of Union Bag who were guests
at that time? |
A. Yes, sir.
Q. If you can recall their names, tell the Court who they
were.
A. Well at different times there was different people. We
have had Mr. Brenner there, Mr. March, Mr. Whitley, Mr.
Brown, Mr. Dupree, Mr. Hubbard, Mr. Finley, I believe,
Mr. Edwards.
(R. 302, 303, 304, 305)
Direct Testimony of:
Jerry Polk, Maintenance Superintendent,
Weyerhaeuser Corp.
Mr. Polk, what is your present occupation or employ-
ment?
A. Maintenance superintendent at the Weyerhaeuser
Company in Plymouth. (N.C.)
Q. Directing your attention to the year 1965, did you
visit Ocracoke Island as a guest of Berkley. Machine
Works?
A. Yes, sir.
Q. Directing your attention to the year 1967, did you
visit Ocracoke Island as a guest of Berkley Machine Works.
A. Yes, sir.
Q. Now on those occasions that you were a gues
at Ocracoke Island, were there other guests who were em-
ployees of Weyerhaeuser who accompanied you on those
trips?
A. Yes, sir.
qe 09
65a
Q. Can you recall their names?
A. Jack Leary.
Q. Are there any others?
A. Otha Powell.
A. Yes, sir. Bill Statesbury.
A. Yes, sir, Bill Stotesbury.
Brewer.
A. They were all in maintenance and engineering.
Q. While you were a guest of Berkley Machine Works
* * * did you know whether or not there were other em-
ployees of other customers of Berkley who were also guests
on those occasions?
A. On some occasions there were.
Q. Well, can you remember the names of those other
guests who were not employees of Weyerhaeuser?
A. The gentlemen that was just here, Slim Eubanks, was
there at one time I remember. Scott who has been a witness
was there.
(R. 319, 320, 321)
Direct Testimony of:
M. C. Eddins, Engineer, American Oil Company
Q. Calling your attention to the years 1963 through
1967, where were you employed during that time?
A. I was employed at the American Oil Refinery in York-
town, Virginia.
Q. Directing your attention to the year 1963, did you
visit Ocracoke Island, North Carolina as a guest of Berk-
ley Machine Works?
A. Yes, I did.
Q. Would that also be true for the year 1964?
A. Yes.
66a
Q. Would it also be true for the year 1965?
A. Yes.
Q. And for the year 1966?
(). And you were also a guest, were you not, again in
1967?
A. Yes, sir. I was.
Q. Now on the occasions that you were a guest, were there
other employees of American Oil Company who were also
guests of Berkley on Ocracoke Island?
A. Yes there was.
Q. Can you recall their names?
A. Yes. Mr. A. J. Scott, who was also a maintenance
supervisor, who has, I’ve been there with him. Br. Bob
Argus, who was plant manager. Mr. Wade Horn, who is
the mechanical superintendent in the refinery. And Mr.
Carney. He was the general foreman in the refinery.
Q. While you were a guest * * * on Ocracoke Nsland, do
you know whether or not there were employees of other
customers of Berkley Machine Works who were also guests
on those occasions?
A. Yes.
Q. Can you recall the names of some of those people?
A. I didn't get too well acquainted with these people.
However, I do remember a Jerry Polk and
A. Polk I believe was his name. And a man by the name
of Eubanks. I believe they called him Slim Eubanks.
(R. 329, 330, 331)
Direct Testimony of:
Richard Harold Deal, Project Engineer,
Albemarle Paper Company.
Q. Mr. Deal, what is your present occupation or employ-
ment?
A. I'm a project engineer with Albemarle Paper Com-
pany.
67a
Q. Directing your attention to the year 1964, did you
visit Ocracoke Island, North Carolina as a guest of Berk-
ley Machine Works?
A. Yes, I did.
Q. On that occasion were you one of several other guests
who went on fishing trips?
A. Yes. I was.
Q. * * * while you were there also, were there employees
of other customers of Berkley’s there?
A. Yes. There were.
Q. Can you recall their names?
A. Only a couple of them John Brenner, who had
worked for Johns-Manville who I had formally worked for,
and Slim Eubanks, who was, both of them were with
Union Camp.
Q. * * * the other employees of Albemarle who were
down there with you, can you recall their names?
A. I know that Ray Coker and John Gabriel were there.
They were both in the maintenance department, I believe,
and Jack Gladstone and perhaps Francis Hanks,
68a
APPENDIX E
(R. 164)
Cross-examination testimony of :
Martin Ellers (Drill Carrier)
Q. Now, Mr. Ellers, do you have any recollection other
than the fact that you visited Ocracoke during the years
from ’63 to 67, when during those years you were there?
A. No, I can’t tell you that. [ was there during the year
but I can’t tell you any dates.
Q. Can you tell me whether you were there more than
one time a year?
A. Yes. We were sometimes as many as three times in a
year.
(R. 194-195)
Cross-examination testimony of :
Andrew Scott (American Oil Company)
Q. Do you remember how many times you went to Ocra-
coke from 1963 to 19671
A. In what, four years.
Q. That'd be five years.
A. Five years.
Q. Just approximately.
A. Oh, I would say 12 to 15 times.
(R. 225)
Cross-examination testimony of :
John Lee Wood (Drill Carrier).
Q. Did you keep any sort of records like perhaps a diary
or anything about your trip to Ocracoke?
A. No ma’am.
69a
Q. Could you tell me at all how many times you went
which year?
A. Vd find that hard to do too, really.
Q. Did you go more than once?
A. We—on occasion we could have gone twice.
(R. 311, 312)
Cross-examination testimony of :
Jerry Polk (Weyerhaeuser)
Q. Now, I believe you testified that you made some visits
down to Ocracoke Island during the years 1943 through ’67,
was that correct?
A. I’m sure I did. I can’t pinpoint the dates or the years
but I feel sure that I went at that time. Yes.
Q. Now, what about 1963?
A. I feel that I did, but I can’t say for sure. It was
about that time I went down there. And I’ve been prac-
tically every year since at one time or another.
Q. Would you go more than one time a year?
A. I have. Yes.
(R. 335)
Cross-examination testimony of:
Richard H. Deal (Albemarle Paper Co.)
Q. Mr. Deal, I believe you testified, did you not, that
during the years '63 to ’67 you visited Ocracoke once and
that was in ’64, is that correct?
A. I have been down there several times.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.